[Senate Hearing 108-11]
[From the U.S. Government Publishing Office]
S. Hrg. 108-11
FINANCIAL CONDITION OF THE ELECTRICITY MARKET
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
TO
RECEIVE TESTIMONY REGARDING THE FINANCIAL CONDITION OF THE ELECTRICITY
MARKET
__________
MARCH 4, 2003
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Committee on Energy and Natural Resources
______
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
PETE V. DOMENICI, New Mexico, Chairman
DON NICKLES, Oklahoma JEFF BINGAMAN, New Mexico
LARRY E. CRAIG, Idaho DANIEL K. AKAKA, Hawaii
BEN NIGHTHORSE CAMPBELL, Colorado BYRON L. DORGAN, North Dakota
CRAIG THOMAS, Wyoming BOB GRAHAM, Florida
LAMAR ALEXANDER, Tennessee RON WYDEN, Oregon
LISA MURKOWSKI, Alaska TIM JOHNSON, South Dakota
JAMES M. TALENT, Missouri MARY L. LANDRIEU, Louisiana
CONRAD BURNS, Montana EVAN BAYH, Indiana
GORDON SMITH, Oregon DIANNE FEINSTEIN, California
JIM BUNNING, Kentucky CHARLES E. SCHUMER, New York
JON KYL, Arizona MARIA CANTWELL, Washington
Alex Flint, Staff Director
James P. Beirne, Chief Counsel
Robert M. Simon, Democratic Staff Director
Sam E. Fowler, Democratic Chief Counsel
Lisa Epifani, Counsel
Leon Lowery, Democratic Professional Staff Member
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 2
Cassidy, Frank, President and COO, PSEG Power LLC................ 13
Johnson, Hon. Tim, U.S. Senator from South Dakota................ 38
Silverstein, Evan J., General Partner, SILCAP Hedge Fund......... 9
Smith, Hon. Gordon, U.S. Senator from Oregon..................... 1
Smith, Suzanne G., Director, Corporate and Government Ratings,
Standard & Poor's.............................................. 16
Sokol, David L., Chairman and CEO, MidAmerican Energy Holdings
Company........................................................ 23
Svanda, David A., President, National Association of Regulatory
Utility Commissioners, and Commissioner, Michigan Public
Service Commission............................................. 3
Thomas, Hon. Craig, U.S. Senator from Wyoming.................... 1
APPENDIXES
Appendix I
Responses to additional questions................................ 45
Appendix II
Additional material submitted for the record..................... 57
FINANCIAL CONDITION OF THE ELECTRICITY MARKET
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TUESDAY, MARCH 4, 2003
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 10:03 a.m., in
room SD-366, Dirksen Senate Office Building, Hon. Craig Thomas
presiding.
OPENING STATEMENT OF HON. CRAIG THOMAS, U.S. SENATOR FROM
WYOMING
Senator Thomas. Thank you for being here this morning. The
purpose of this hearing is to take testimony on the current
financial conditions facing the electric sector and to explore
potential solutions, of course, to improve the financial
challenges. I suppose the primary questions we will discuss are
what caused the current financial situation in the electric
industry? What are the effects of current financial conditions
on the energy infrastructure? What remedies should we consider?
And we will look forward to hearing from the witnesses.
Very briefly, it seems to me that this is one of the real
key issues that we have to deal with. Things have changed so
much in the electric sector. We will be taking up hopefully an
energy policy rather soon. I think that electricity should be
part of that. It probably affects more people than any other
aspect of energy. We have changed so much in terms of the
method of generation and the transmission.
So I have introduced, as matter of fact, an electric
transmission and reliability bill that I hope will extend and
open nondiscriminatory access, remove some of the antiquated
statutory barriers that stand there, increase investment
hopefully, and deal something with the transmission.
So, Senator, do you have an opening statement?
[The prepared statement of Senator Smith follows:]
Prepared Statement of Hon. Gordon Smith, U.S. Senator From Oregon
Mr. Chairman, I appreciate your willingness to put together this
hearing to examine the financial condition of the electricity market.
I must say from the outset, however, that while I am concerned
about the financial condition of the electricity market, I am equally
as concerned about the financial condition of electricity users. In the
Pacific Northwest, we are still feeling the financial effects of the
volatile electricity market of late 2000 and 2001.
Most ratepayers in the Pacific Northwest have seen their power
rates go up by at least 40 percent, and BPA has begun another rate case
to raise rates again next October.
Meanwhile, our energy intensive industries are shuttered, and
Oregon continues to have the second highest unemployment rate in the
country.
I become very concerned when I hear people say that the goal for
the wholesale energy market is competition. In my view, the goal is to
keep the lights on for every American, at reasonable rates. Businesses
from Main Street to Wall Street must also have access to reliable and
affordable energy.
I have read through the testimony of the witnesses before us today,
and they outline the wide range of challenges facing electricity
companies, particularly those with merchant plants or energy trading
and marketing operations. These include: excess generating capacity and
thin margins in parts of the country; extensive credit downgrades since
2001; high levels of debt; the need to refinance tens of billions of
dollars in debt; reduced demand; and continued regulatory uncertainty.
I appreciate the suggestions made by the witnesses concerning the
changes needed. As a new member of the Finance Committee, I will
certainly review the proposals for changes in the tax code as well.
What is clear to me, however, is that there is no ``silver bullet''
that will cure the myriad of ills facing electricity providers,
particularly those with unregulated generation.
In fact, in my view, these ``poor industry fundamentals,'' as they
are referred to by the witness from Standard and Poor's, are also the
result of regulatory and legislative uncertainty that has been going on
for more than 10 years now. Beginning as far back as 1988, we have seen
major proposed rulemaking regarding the electricity industry every two
to three years. Congress passed the Energy Policy Act in 1992, and we
have debated energy legislation for three Congresses now.
We are still working through the proposed rulemaking on standard
market design (SMD). As you know, I have opposed this rulemaking,
because I believe it is unnecessary and unworkable, particularly in the
Pacific Northwest. If there are instances of undue discrimination on
the transmission system, I believe that the Federal Energy Regulatory
Commission (FERC) has the ability, under Order 888 or in the
development of tariffs for regional transmission organizations, to
remedy such discrimination.
I wonder how many members who voted for the 1992 Act, which was
enacted before I began my service in the Congress, thought it would
result ten years later in a 600-page proposed rulemaking on SMD. I only
bring this up to illustrate that, as we contemplate additional
legislation on electricity, I remain concerned that we are potentially
extending for years--if not decades--the regulatory uncertainty facing
the industry.
I want to know what the impact of our actions will be on the end
user, such as the family-owned grocery store in rural Oregon.
In closing, Mr. Chairman, while I appreciate this oversight
hearing, I would ask that any proposed electricity title be the subject
of a legislative hearing before we proceed to mark-up. I believe it is
important that we build the record on such important legislation, and
fully understand the impact of proposed language before moving forward.
I look forward to hearing from the witnesses today.
STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW MEXICO
Senator Bingaman. Thank you very much, Mr. Chairman. I
think this is a very important hearing. I welcome all the
witnesses. I know the focus of this hearing is on the financial
condition of the electric industry. And clearly, that is an
important issue to focus on. I also am going to have some
questions and hope the witnesses will be able to give us some
insights on the issue of supply and whether or not we are
building the necessary capacity to meet the demand that is
going to be there.
I worry a little bit that some of the same circumstances
that we saw leading up to the crisis in California and the
Northwest with lack of hydroelectric power. All these issues
seem to be back again. And, I know the issue of the financial
condition of the industry and the issue of adequate supply are
intertwined. I hope we can get into both a little bit in this
hearing and then perhaps have a separate hearing on the supply
issue.
But thank you very much for having the hearing.
Senator Thomas. Thank you, sir.
Senator.
Senator Campbell. Mr. Chairman, I have a conflict, like
most of us do. So with your permission, I have a number of
questions, some dealing with supply, as Senator Bingaman does.
And I think, if it is all right with you, I would like to
submit those to the witnesses and get some answers in writing.
Most of them are general in nature. There are a few that are
Colorado specific, however.
Senator Thomas. Absolutely. We will do that.
We are very pleased this morning to have Commissioner
Svanda with us, the commissioner of Michigan PSC; Frank
Cassidy, who is president and CEO of PSEG Power; Suzanne Smith,
the director of Corporate and Government Ratings, Standard &
Poor's; Frank Cassidy; and Evan Silverstein.
We are delighted to have you, gentlemen. We will--I am not
going to have an opening statement. If you can hold your
testimony to 5 or 6 minutes, we would appreciate it. And then
we will have some questions.
So Commissioner, if you would like to begin?
STATEMENT OF DAVID A. SVANDA, PRESIDENT, NATIONAL ASSOCIATION
OF REGULATORY UTILITY COMMISSIONERS, AND COMMISSIONER, MICHIGAN
PUBLIC SERVICE COMMISSION
Mr. Svanda. Thank you, Mr. Chairman and members of the
committee. I certainly appreciate this opportunity to speak
before you. I am Dave Svanda. I am a commissioner in Michigan.
I am also the president of NARUC, the National Association of
Regulatory Utility Commissioners.
I would like to supplement my written testimony. And I
would like to supplement it with some broader and also with
some more specific observations. The first of these is to go
directly to the question that you asked first of all. And that
is, what are the current financial realities?
With respect to those financial conditions that we all care
about, our statements, NARUC and Michigan, are virtually the
same. Our views are the same. The analysis is the same. And it
is consistent with all of the other commenters that we read
comments from or hear from. And it is consistent in that we
express that conditions are certainly not ideal today.
However, this sector does not operate in a separate vacuum
from the rest of the economy or from other capital markets. I
mean, we need to view this sector in the context of those
broader markets.
On the system, demand is down. So the system is not being
challenged today. This country has been on a capital investment
starvation diet, especially with regard to transmission, for
about two decades. Transmission transfer capacity, in fact,
peaked in the 1980's. Reasonable estimates are that we need
something north of $55 billion invested in electric
transmission upgrades alone, never mind the other components
and never mind other related cornerstones, such as gas
transmission.
Transmission assets are in fact bedrock American
infrastructure investments and should be acknowledged by all
for what they are. My written testimony provides very concrete
examples of what great investments in transmission happen to be
today.
In many respects, this country's transmission system is a
dumb, mechanical switch system from the last century. Our
investment incentives, our focus for the future, should be
guiding us to an Internet smart and Internet speed type of grid
to help us maintain our position of world leadership.
National average headline conditions do not really reflect
the true on-the-ground electricity demand and supply
conditions, as we experience them out in the States. Load
pockets today are in fact crying for investment, but those
cries are drowned out by headlines of national generation gluts
and other circumstances. Investors really need help in seeing
the trees in the forest.
Let me turn to my next topic, and that is incenting
investment. Recognizing that there are some global
uncertainties that affect all of our thoughts, there are still
methods for opening the investment spigot. Those policies that
should be pursued, I believe, incent investment that help us to
accomplish other major national objectives.
The first would be to focus on customer needs and incent
investment to enhance reliability, to support the information,
manufacturing, and lifestyle practices of today, and to incent
investing to remove bottlenecks. And I would suggest here a
carrot and stick approach, that we in fact provide incentives
for the removal of bottlenecks where they exist in the
transmission system. And to the extent that the incentives of
the carrots are not taken up, that stick be applied. And that
stick would be penalties for those who own bottlenecks. And
those penalties may apply after two or three years of
congestion season ownership of those bottlenecks.
I think there should be a focus on technological
advancement, incent investing on new smart, good technologies
that exist today, but have simply not been rolled out in any
major fashion. We could certainly export those technologies,
both for our economic benefit and for global fuel efficiency
purposes.
We need to focus on a balanced fuel portfolio and demand
response mechanism, including those fuel sources that are most
abundant on this continent, and I would note clean coal
technology specifically. We need to focus on maintaining
America's competitive advantages and fostering wise North
American continental energy utilization and, lastly, focus on
enhancing national security. The American public and the
investing public would certainly understand these types of
investment incentive objectives.
Let me speak briefly to restoring confidence or
specifically corporate structure. Recent U.S. corporate history
has taught most of us that it is important to have access to
understandable, credible, ethically correct transparent and
accurate financial information. Altering the allowed
relationship between a public utility and its holding company
parent should only be undertaken in a manner in which respects
our recent history lesson and applies what it has taught us.
Examples of parent-induced problems are plentiful. I would
be happy during question and answer or on follow-up to discuss
details of which I am all too painfully aware with respect to
this and if you have interest.
Let me summarize by saying that there are huge unmet
electricity, and in fact energy generally, infrastructure
demands. Investment is required for national security, for
reliability, for replacing old and outdated technology, to feed
and then sustain this country's economic recovery, to enhance
fuel diversity and energy conservation, and to give U.S.
customers the energy options that they need.
U.S. infrastructure is a stable investment and compares
very favorably when you measure its returns against most
indices available today. Investment options will generally fall
into four categories. First will be the traditional public and
IOU-type utilities; second, unbundled asset utilities; third,
independent power producers; and fourth, transmission. All of
these have their place. They are all right for particular
circumstances.
A balanced strategy would include investment in each. A
balanced investment incentive program crafted by this committee
would give equal weight and value to each of these categories.
Thank you. And I look forward to your questions.
[The prepared statement of Mr. Svanda follows:]
Prepared Statement of David A. Svanda, President, National Association
of Regulatory Utility Commissioners, and Commissioner, Michigan Public
Service Commission
Thank you Mr. Chairman and Members of the Committee for this
opportunity to share my perspectives with you on the financial
condition of the electricity market and some suggestions I would offer
to improve it. I am David A. Svanda, President of the National
Association of Regulatory Utility Commissioners (NARUC) and a
Commissioner on the Michigan Public Service Commission. I respectfully
request that NARUC's written statement be included in today's hearing
record as if fully read.
NARUC is a quasi-governmental, nonprofit organization founded in
1889. Its membership includes the State public utility commissions for
all States and territories. NARUC's mission is to serve the public
interest by improving the quality and effectiveness of public utility
regulation. NARUC's members regulate the retail rates and services of
electric, gas, water and telephone utilities. We have the obligation
under State law to ensure the establishment and maintenance of such
energy utility services as may be required by the public convenience
and necessity, and to ensure that such services are provided at rates
and conditions that are just, reasonable and nondiscriminatory for all
consumers.
Energy drives our economy and indeed our entire society. Yet today,
our energy markets are in turmoil. This turmoil may eventually
undermine the country's economic recovery and future economic growth,
unless we develop and pursue policies that restore confidence and open
the capital spigot of this nation. These policy objectives need to
provide stability and consistency, and in so doing, will promote the
confidence necessary for renewed investment in our energy
infrastructure.
I. CURRENT FINANCIAL CONDITIONS FACING ELECTRICITY SECTOR
The last two years have been among the most turbulent periods in
the history of the electricity business in the United States. While
investor confidence is lacking in the economy as a whole, these last
two years in the electric industry have undermined the stability of the
nation's energy markets, by shaking investor's confidence in the
electric industry as a long-term investment and seriously eroding the
liquidity necessary for the performance of efficient markets. According
to the Electric Power Research Institute (EPRI), the electric
industry's credit situation is the worst in over 70 years, with half
the industry rated below investment grade. Today, a limited number of
banks are controlling the lending market at a time when $25 billion
needs to be refinanced in 2003 alone. The equivalent of one year's
electric industry revenues, $250 billion in market capitalization, has
been lost to the industry. The equity value of the merchant power
sector alone has dropped from $145 billion to under $10 billion. The
combined capital expenditures of regulated and deregulated electricity
companies, as a fraction of their revenues in the 1990s, was 12%. This
is half the expenditure rate during the Depression and World War II.
The electricity industry is almost last among the 53 largest U.S.
sectors in terms of investment in infrastructure technology
development.
Paradoxically, the industry is struggling with an oversupply of
generation, in some regions, that has depressed wholesale power prices
and further weakened generator finances. I have heard disheartening
words from utility executives trying to describe an operating and
business environment that they have never experienced.
Some of the nation's first attempts to restructure an industry that
has remained essentially unchanged for nearly a century have produced
some regrettable headlines, but have also revealed the vast
opportunities that market restructuring can offer. In Michigan, we did
a back-of-an-envelope calculation of the cost to Michigan ratepayers of
continuing to have a constrained transmission system, versus an open
access transmission system. With open access, Michigan customers could
save from 5-15 percent on their energy bills. This represents hundreds
of millions of dollars of potential savings to Michigan customers. To
tap these potential savings, investments to alleviate transmission
constraints must be made. Load pockets throughout the United States
would benefit from additional generation investment or transmission
expansion, and in fact represent excellent investment opportunities for
savvy investors.
The price of doing nothing is instability, uncertainty and lost
opportunities to use our resources wisely. These are characteristics
that can only serve to depress further investment in this critical
industry. Bringing clarity and certainty to the manner in which
electricity services are provided in this country will go a long way
toward settling the investor jitters so evident today.
II. POLICY GOALS THAT PROMOTE CONFIDENCE IN ENERGY MARKETS
A. Regional nature of electricity markets
Most critically, it must be recognize that electricity markets have
developed based on regional differences. These regional markets have
different population densities, unique transmission system
characteristics, disparate local fuel sources, differing dispatch
protocols and generation ownership. These all reflect unique regional
characteristics of geography, and economic development.
FERC has recognized that there is not just one energy market in the
country, but rather linkages between distinct regional markets. State
regulators and others have taught this to FERC and also recognize the
regional nature of electricity flows, siting needs, and transmission
expansions and additions. NARUC along with the National Governors
Association, regional Governors associations, FERC and others have been
perfecting multi-state entities (MSE) to maximize the efficiency of the
approval process for the implementation of infrastructure improvements.
We have been collectively working with the Department of Energy to fund
the creation and development of these regional organizations. We
believe these regional organizations will be important for
communications, coordination, and for building confidence between
state, regional and federal industry agencies.
In the past, a state needed regional ties to improve the
reliability of its electricity service, to help a state with a
localized supply problem. Now, beyond reliability, states need strong
regional ties to survive economically in the global market place.
Finance and regulation are no strangers to regional markets. Oil
and gas production have long been associated with the Gulf area. The
Midwest is known for its automobile production infrastructure and
expertise. Aluminum production is the pride of the Northwest. However,
investors will shift their investment philosophy from national to
regional opportunities in the electric industry only if the uncertainty
in the electricity market can be resolved by evidence of regional
cooperation in critical areas. Policy makers at both the federal and
state levels can encourage this investment policy shift by promoting
and pursuing regional markets and policies.
B. Complementary regulatory practices
Next, consistent federal and state policies that support investment
in energy infrastructure must continue. Complementary policies serve as
the cornerstone for promoting consistency that is necessary to build
confidence in the energy industry. These policies can lead to standard
business practices that all industry participants can rely on. At the
same time, they are critical to providing transparency and reducing
market risks.
My own home state of Michigan provides an example of how such
policies can induce investments in electricity infrastructure markets.
Our two largest electric utilities were formerly fully integrated,
owning generation, transmission, and distribution facilities. Recently,
these two Michigan utilities have unbundled, or have chosen to divest,
not their generation, but their transmission assets to non-affiliated
entities. Trans-Elect and Kohlberg Kravis Roberts (KKR), the purchasing
companies, are pursuing a competitive business model for transmission
additions and expansions in a business environment with consistently
supportive federal and state policies.
The purchase of the Consumers Energy transmission system by Trans-
Elect was the first outright sale of a U.S.-based transmission system
to an independent transmission company. It was also the first time FERC
approved such a sale. The combination of FERC's strong endorsement of
the Trans-Elect business model, the ability of Trans-Elect to function
within the business standards adopted by the Midwest Independent System
Operator, FERC's first qualified RTO, and the support of Michigan
regulatory and legislative policy permitted Trans-Elect to bring the
complicated transaction to a successful close. Moreover, this business
deal has created a solid foundation for future transactions. The sale
was worth approximately $290 million.
At the end of last year, DTE Energy (DTE) announced that it was
selling its transmission subsidiary, the International Transmission
Company, to affiliates of Kohlberg Kravis Roberts for about $610
million. This business decision was made in part because of consistent
federal regulatory policy and Michigan law, both of which promote the
independent operation of the electric transmission grid within the
footprint of our regional transmission operator, the Midwest
Independent System Operator.
DTE specifically commented on the foresight of the FERC and the
Michigan Commission in creating a regulatory structure that supports a
more competitive and efficient U.S. power industry. KKR is also looking
forward to pursuing additional transmission opportunities as other
utilities follow this investment trend. In both of these transactions,
the gains from the sale were split 50/50 between the selling utilities
and their ratepayers.
It is interesting to note that both of these transmission sales,
almost one billion dollars of new investment, were made possible in
part because of consistent state and federal policies that encourage
participation in the new regional Midwest Independent System Operator
(MISO). The stability of regional open access rules and the promise of
transparent and vibrant Midwest transmission markets no doubt
encouraged investors to commit substantial capital to an otherwise
stagnant utility sector. Several other transmission owning MISO
participants have also committed to additional transmission
construction that probably would not have occurred without the
establishment of this FERC approved regional transmission organization.
Early on in the electricity restructuring saga Michigan realized
that retail markets can only flourish if there is a vibrant regional
wholesale market and have chosen this path as part of our state's
economic development program. Although some of the other Midwest states
have not embraced retail choice, they still benefit from and support
participation in the MISO wholesale market.
A very positive development in supporting federal and state
regulatory practices involves the common interest and cooperation in
market monitoring. I don't need to describe the malaise created in
California markets just a couple of years ago. What I want to highlight
is the joint efforts of the federal government and states, working
though regional organizations like the PJM and MISO, to prevent future
market abuses. In doing so, much uncertainty has been removed from the
markets and important steps have been taken to rebuild confidence in
the fair and efficient operation of the nation's energy markets.
C. State regulatory environment
As a public utility Commissioner, I would be remiss if I failed to
identify the significant influence that state utility regulatory
commissions have with respect to energy investment decisions. A stable
regulatory environment, characterized by fair and balanced oversight of
utility operations, along with well-targeted incentives, can go a long
way to encourage a supportive climate for investors within a state.
Consistency is the hallmark for regulatory stability. Decision-
making processes and approaches should be transparent and clearly
understood so investors understand the ground rules and are able to
effectively evaluate and assess the risks and rewards of conducting
business within the state's jurisdictional purview. Abrupt and
precipitous changes should be avoided, except under the most compelling
circumstances.
Decision-making should be balanced, rewarding good performance as
well as penalizing poor results. I firmly believe that an increased
role for regulatory incentive initiatives is needed. Additionally, I am
convinced the reward side of the regulatory equation to influence
decisions is significantly underdeveloped. Greater reliance on the
carrot approach is a tool in the regulatory kit that offers great
potential to attract the investment community. The sharing of net
proceeds from the transmission asset sales of Michigan's two large
investor owned utilities discussed above is a specific example of how
application of incentives can encourage decisions favorable to the
investors, while accomplishing state and federal competitive policy
goals relating to transmission independence. Likewise, securitization
financing of stranded assets was a key factor encouraging Michigan
utilities to agree to open their markets to competition, an initiative
very positively received by Wall Street. Securitizing investment in
strategic new investments may also be an attractive inducement to
invest.
Though some states in some regions have questioned FERC's policy of
encouraging investment in transmission assets by providing investment
incentives and NARUC has taken no position on FERC's policy, I support
it. FERC has come to the same conclusion that we in Michigan have come
to, that there are advantages to well designed incentives. Incentives
may improve efficiency and if done properly can be a good tool to
encourage investment.
Working cooperatively with sister state and local agencies that
exert influence over energy investment decisions is another way states
can improve the investment environment. Fertile areas for coordination
include siting, permitting, safety, economic development, and taxation.
I am convinced that a strong cooperative effort among Michigan state
and local agencies and stakeholders played a significant part in the
several thousand megawatts of merchant plant generation brought on in
Michigan over the past three years. In particular, I am pleased with
the considerable Commission effort extended to working with merchant
generation developers to help communicate the importance of these
facilities to the State, in particular speaking to energy reliability
and the State's competitive position as a place to conduct business.
With respect to the influence of state regulation on the energy
investment environment, no discussion would be complete without mention
of regulatory lag. Tardy recovery of prudent investment costs is
troublesome to investors. There simply is no way to present regulatory
lag in a positive light on that score. Unfortunately, while it may not
be legally possible to eliminate the temporal distance between cost
incurrence and recovery, increased focus and attention to substantial
reduction should be considered as an option with substantial potential
to strengthen the investment climate. Examples of efforts in Michigan
to address this issue include a time deadline for Commission decisions
in utility rate cases and responsive initiatives for electric fuel and
power purchases and gas commodity cost recovery through variable
monthly supply surcharges. Securitization of certain utility assets,
discussed above, is another example. Other opportunities should be
explored as well.
D. Public Utility Holding Company Act (PUHCA)
Traditional sources of capital have moved away from the electricity
industry. However, there are potential investors that apparently are
not considering investment because of PUHCA. Congress should reform
PUHCA. However, in doing so should allow states to protect the public
through maintaining effective oversight of holding company practices
and expanding state access to holding company books and records,
independent of any similar authorities granted to the federal
regulatory bodies.
Access to books and records required to verify transactions
directly affecting a companies regulated utility operations is of vital
importance to state commissions. Requests for such books and records by
a commission, its staff, or its authorized agents should be deemed
presumptively valid, material, and relevant, with the burden falling to
the company to prove otherwise.
FERC and the states ought to be given greater access to corporate
documents to conduct investigations into financial dealings. Each time
statutory exemptions were made to PUHCA, safeguards to protect utility
consumers were included. Enhanced state and federal access to data and
information will provide consumer protection safeguards in an
environment without the PUHCA safety net, while promoting investment.
E. Promotion of Efficient Generation Technology
Renewable energy sources such as biomass, geothermal energy, wind
and solar power make up 4 percent of U.S. energy production. A diverse
generation portfolio provides the best assurances for a secure energy
future and, yet, investment in renewable sources has remained low.
An increase in tax incentives for investments in renewable
technologies would allow for a greater penetration of these sources in
the U.S. energy market. Section 45 of the Internal Revenue Code
currently provides the owners of wind facilities, closed-loop biomass
facilities, and chicken waste facilities a production tax credit for
each kilowatt-hour of electricity generated by those facilities. Such a
credit has been instrumental in the development of the wind generation
industry, providing the essential boost for this developing technology.
The extension of the production tax credit to other renewable sources
will promote the development of these emerging technologies.
III. CONCLUSION
The economic prosperity that we enjoy as Americans has been fueled
by energy. Energy has fueled our evolution through agricultural
development, through our industrial transformation, and into our
premier status in the global economy. The nation's continued economic
growth, indeed our national security, depends on the efficient
operation of energy markets. Though these markets are facing some of
the most turbulent times since the industry's infancy, there are
important steps that we can take to the restore confidence of all
market participants in the fair and efficient operation of these
markets. These steps include: (1) recognizing and working with the
regional nature of the energy markets; (2) encouraging complementary
federal, regional, and state regulatory practices; (3) working as state
regulators to exercise balanced decision making, providing the right
incentives, and working cooperatively among ourselves and our national
colleagues to provide a stable market with consistent rules; (4)
reforming PUHCA in a manner that allows the states to protect the
public and provide needed transparency; and (5) provide tax incentives
to promote greater development and use of renewable energy. I am
convinced that these policies can help build confidence of investors,
consumers, utilities, and other market participants in our energy
markets.
Thank you for your attention. I look forward to answering any
questions you may have.
Senator Thomas. Okay. And thank you, sir.
Mr. Silverstein.
STATEMENT OF EVAN J. SILVERSTEIN, GENERAL PARTNER, SILCAP HEDGE
FUND
Mr. Silverstein. Thank you. As you know, my name is Evan
Silverstein. I am the general partner and portfolio manager at
SILCAP, L.L.C., a market neutral hedge fund that principally
invests in utility and energy companies. I want to thank this
committee for inviting me here today so I can provide
perspective on the current status of the energy industry and
why are we in this position and what we can do to help
transition to a more constructive framework.
I have spent almost 28 years, my entire professional
career, specializing in the utility/energy industry, dating
back to 1975. In my role, I have constantly evaluated macro-
and micro-economic, political, and sociological trends in
assessing the investment attractiveness of the industry and its
companies. As a result, I would like to view myself as an
expert, a student of the industry, and feel a strong sense of
emotional attachment.
While my professional role is to evaluate these issues and
make the correct investment decisions, to me that is less
important than helping mold the more constructive atmosphere
for energy policy.
I would like to summarize my testimony in the following
points: It is critical that we develop a comprehensive energy
plan that encompasses environmental and tax policy. This is the
only way to create an environment that provides for capital at
reasonable cost and availability to support infrastructure
development. Anything short of that can endanger our ability to
achieve low cost energy independence. I do not want to downplay
the significance of what has happened over the past few years.
But I am very concerned that, based on history, we may
overreact to the short run and not stay focused on the more
important issue of establishing policy for long run
development. We need to take lessons learned from the past few
years to improve future market structure.
Since 1975, when I entered the industry, fuel shocks,
nuclear crisis, gas restrictions, PURPA have all served to
produce financial stress and political and regulatory responses
that were overreactions, that sacrificed constructive long-term
policy development. Our energy and environmental policy has
been in a state of flux for too long. We need some stability
and certainty in our policy in order to attract reasonably
price capital.
High anxiety and uncertainty are the chief causes of
capital dislocation. We have to decide what our social
objectives are and agree that a policy that obstructs building
transmission pipelines, the use of coal and nuclear, and
drilling for new natural gas is less of a policy than just say
no.
Certainly the development of renewables, clean coal
technology, hydrogen-based solutions and conservation are all
part of the future. But they are not ready to carry the load.
Recent stresses in natural gas are indicative of infrastructure
shortcomings. We have to find a way to integrate State and
Federal needs into a common goal. We need to complete our
investigations as soon as possible. We need to move forward.
To be sure, many factors contributed to the current crisis.
The 1990's were a euphoric environment that produced large
amounts of cheap and undisciplined capital. Industry, such as
merchant energy, technology and telecommunications, were
unfunded, which resulted in significant excess capacity.
Moreover, the extensive use of leverage, a declining economy,
and an unprecedented credibility crisis produced a severe
liquidity and capital crisis in the industry.
Greed was another characteristic of the 1990's. And this
human trait, combined with questionable ethical and legal
behavior, contributed to the collapse of the merchant and
trading business. However, while competitive model has been
damaged, I do not believe it has failed. In my view, the
California model of forcing electricity into the spot market
without ability to contract bilaterally was its fatal flaw.
Competitive markets are operating and developing in other
parts of the country. Nevertheless, the market development is
being hindered by the need for the development of some kind of
independent transmission model that provides credibility and
sends the right economic signals. I believe transmission should
be independent under any model adopted.
A combination of market forces and properly incented
regulatory structures are ideal. We cannot judge the success of
any model by whether prices are going up or down. Whatever
model we adopt is supposed to produce the most sufficient price
at this point in time to meet short- and long-term needs,
including capital investment.
The industry certainly needs to be monitored more closely,
have some sort of regulatory oversight, and provide significant
penalties for abusers. But we have to be careful not to over
regulate. We need to allow market forces to drive good decision
making and allow development of creative and ingenious
solutions to our energy problems.
In this regard, PUHCA needs to be reformed to allow for
consolidation that is not in conflict with market power issues
and allow for the injection of fresh capital. Consolidation is
a natural response to financial stress.
Finally, we need fuel diversity. Every time in history when
we have relied on one single fuel source for incremental needs
it has been quite a mistake. Diversification is the key to
long-term energy management.
The last few years have been characterized by severe
dislocation. Nevertheless, if we do not focus on incorporating
on the lessons learned into the future policy and structure,
the pain went for naught. Our economic prosperity and perhaps
national security is dependent on our ability to move forward.
I hope this hearing signifies the beginning of this
process, because we need to succeed.
[The prepared statement of Mr. Silverstein follows:]
Prepared Statement of Evan J. Silverstein, General Partner,
SILCAP Hedge Fund
As you know, my name is Evan J. Silverstein. I am the general
partner and portfolio manager for SILCAP LLC, a market neutral hedge
fund that principally invests in utilities and energy companies. I want
to thank this committee for inviting me here today so I can provide
perspective on the current status of the energy industry, why we are
here, and what can we do to help transition us to a more constructive
framework.
I have spent almost 28 years--my entire professional career--
specializing in the utility/energy industry dating back to 1975.
In my role, I have constantly evaluated macro- and micro-economic,
political, and sociological trends in assessing the investment
attractiveness of the industry and its companies.
As a result, I would like to view myself as an expert student of
the industry to which I feel a strong sense of emotional attachment.
While my professional role is to evaluate these issues and make the
correct investment decisions, to me that is less important than helping
mold a more constructive atmosphere for our energy policy.
Clearly, the energy industry is in a state of crisis at a
particularly vulnerable time for our country. I believe it is
imperative that we put aside self-interests and develop a cohesive
energy, environmental, and tax policy in order to create a stable and
more certain environment for energy investment.
Low cost energy and independence has been one of the great
underpinnings of this great country, and I am concerned we are in
danger of losing that advantage. As I will discuss later, I do not want
to downplay the seriousness of events over the past few years that
included unethical and possibly illegal behavior on the part of some
industry participants. However, I'm very concerned that if we fixate on
those issues, we may lose sight of the more important issue of
developing a long term structure for energy investment. The tendency to
overcorrect for the most recent problems starts us on a trend that
creates other obstacles down the road. I have seen it happen before.
While the specifics of each crisis may be different, we have been here
before.
In 1975, when I first came into the industry, it was facing severe
dislocation as result of oil and gas fuel shocks. A handful of
companies were on the brink of bankruptcy and capital was tight and
expensive. Our response was to eliminate the use of natural gas for
electricity production and promote the development of nuclear power.
With runaway inflation and oil prices expected to exceed $50 a
barrel, nuclear was supposed to be our path to energy independence.
However, lax oversight in the construction and operation of these
facilities, highlighted by the Three Mile Island accident, led to the
shutdown of the construction of these facilities in midstream and, once
again, created severe financial crisis that led to major write-offs,
some bankruptcies, and significant excess capacity.
We then decided that nuclear was not such a good idea. We imposed
tremendous safety requirements as a reaction to the problems and
effectively made nuclear a stranded asset. With fuel prices subsiding
and gas now in oversupply, we removed restrictions on gas for electric
generation and identified that as our environmentally preferred fuel.
We also implemented PURPA, which was supposed to promote the
development of the independent power industry.
We developed pricing umbrellas theoretically based on avoided cost,
but in reality wound up being overstated, resulting in another layer of
significantly above-market stranded costs that needed to be addressed.
In almost all these periods, the response to the most recent crisis
created an overreaction that led to additional inefficiencies.
I am very concerned that we are in that very position today and
it's what we need to avoid. The factors that have put us in the current
crisis consist of macro, micro and psychological forces that came
together to produce somewhat of a perfect storm. The 1990's were
generally a euphoric environment for this country which led to the
existence of cheap and easily available capital. This led to an
unprecedented investment in merchant plants with little assessment of
the risks involved. The expectation was that growth would continue
unabated and every plant would be needed and produce attractive
returns. The more companies invested, the higher there stock prices
rose.
At the same time, another phenomenon was at work. The pressure to
show earnings growth was severe across the entire stock market and the
use of undue leverage became more and more prominent, especially since
investors, fixed income analysts and even rating agencies did not seem
to object. As these conditions were reaching their heights, industry
conditions began to change. The failed deregulation experiment in
California which led to runaway prices, the unethical and perhaps
illegal behavior of certain market participants, the significant
failure of many companies, overbuilding and a significantly weakening
economy has created a credibility crisis that has effectively shutdown
reasonable cost capital to the industry and promoted a liquidity crisis
in some cases.
A significant pullback on the part of the banks because of
overexposure to the merchant industry and the tremendous risk aversion
on the part of investors have made capital availability way too tight
and costly.
While I do not condone unethical or illegal behavior, we should not
be surprised by what has happened. Most of it has been driven by the
human trait of greed. Greed on the part of investors expecting to make
easy money in the stock market, greed on the part of market
participants who saw an opportunity to take advantage of market
dislocations and inefficiencies and greed on the part of company
managements trying to drive up stock prices to get rich. We all
contributed in some sense.
While capital to the merchant industry is clearly limited, capital
for infrastructure development is available as long some certainty
exists. Infrastructure-type assets like pipelines and transmission are
already changing hands and integrated energy companies that are
financially strong and are not overwhelmed by merchant issues can raise
capital on somewhat reasonable terms. Nevertheless, the uncertainty
surrounding our energy and environmental policies at both the state and
federal levels continues to be an issue and there is nothing that
raises the cost of capital more than uncertainty.
When I think of how to remedy this situation, I submit that we have
to make a strong commitment to developing a comprehensive solution that
includes energy, tax and environmental policy. This cannot be
piecemeal. We have to decide what our social objectives are and make it
clear that a policy that does not allow for the building of
transmission and pipelines, the use of coal and nuclear, and new
drilling for natural gas is less of policy than a ``just say no''
approach.
Certainly, the development of renewables, conservation, and
technological development of things like clean coal technology, all
have a place in our future but will have to evolve and are not yet
ready to carry the entire load. What we need is certainty and
visibility. We need to commit to a plan that is agreed upon by all
political factions such that it has staying power. To be sure, whatever
is adopted may be modified over time as we learn from experiences, but
we need to avoid radical shifts dominated by political influence.
Our ability to achieve this is even more challenged in electricity
because of the constant state-versus-federal conflicts, but these need
to be overcome to achieve a must-needed solution to a critical issue
for our economy and society. We have to avoid the temptation of
overcorrecting for recent problems and stay focused on long-term
solutions. We cannot say a model is working only when prices are low
and it is broken when prices are up. Any model is designed to achieve
the most efficient price at any point in time to provide for short- and
long-term needs, including capital investment.
In that regard, in my view, while the wholesale deregulated model
has been damaged and is in need of change, it should not be discarded.
While the California model failed, flaws in that model, primarily
forcing all the power into the spot market and not allowing for
contracting, were prime contributors to that failure. There are other
places in the country such as Texas, PJM, New York, New England, etc.
where models are working and continue to improve.
Nevertheless, one of the great failures of our move towards a
deregulated model is that we did not solve our transmission problem
prior to supporting major expansion in merchant capacity. I think this
kind of thinking is also showing up in natural gas today. We promoted
the growing use of natural gas for power generation but did not provide
for the infrastructure needed to support this growth. Thus, with
production declining and usage increasing, we are starting to see
significant stresses.
In my view, both from a credibility and economic standpoint,
transmission needs to be truly independently operated in order to avoid
conflicts of interest and to send the right economic signals. I believe
this is true under any model ultimately adopted. While clearly the
trading of electricity needed to be monitored more closely and subject
to some kind of oversight, we need to assure we do not overregulate. We
need to allow for the development of market forces to drive good
decision making and allow the development of creative and ingenious
solutions to our energy problems.
We should not prescribe solutions, but set good policy with proper
incentives and allow the markets to work. In this regard, we need to
examine PUHCA, which is an antiquated structure and at the very least
allow for changes that would promote consolidation and the injection of
fresh capital into the industry, which undoubtedly should be part of
the rebuilding process.
My final point deals with the need to diversify fuel sources. In my
28-year history, anytime we have relied on one single fuel source to
meet our incremental needs it has been a mistake. My recount of the
past 28 years earlier should indicate that. We are starting to see the
problems with our gas reliance right now even with a weak economy. Coal
and maybe even nuclear has to be part of the mix.
Thank you for your time. This hearing itself is indicative of you
sharing my view of the importance of establishing a cohesive energy
policy. In these difficult times with tremendous uncertainty and
anxiety, we have to ensure we preserve our energy independence. We need
certainty, stability and visibility to bring capital back to this
industry on reasonable terms. I am hopeful we all can agree we need to
get this done.
Senator Thomas. Thank you very much.
By the way, I did not mention your full statements will be
put in the record.
Mr. Cassidy.
STATEMENT OF FRANK CASSIDY, PRESIDENT AND COO,
PSEG POWER LLC
Mr. Cassidy. Thank you, Mr. Chairman. I am Frank Cassidy. I
am president and chief operation officer of PSEG Power, which
is located in Newark, New Jersey, and is a subsidiary of Public
Service Enterprise Group, a diversified energy company, which
is celebrating its 100th anniversary this year.
We are located within the PJMN interconnection, one of the
Nation's largest and most successful competitive energy
markets. And in addition to New Jersey and the PJM region, PSEG
Power also has generating assets in operation or construction
in New York, Connecticut, Ohio, and Indiana. I am pleased and
honored to appear before this committee this morning to
represent my company and the Electric Power Supply Association,
or EPSA, which I currently chair.
Mr. Chairman, as you are aware, there is a constant need
for capital to run our day-to-day operations, build new
facilities, and develop new technologies. Many companies, even
those that are prudently managed and producing excellent
operating results, are facing severe limitations on their
ability to access capital. This is a serious problem and the
one that must be addressed today, if we are to build the 355
gigawatts of new electric capacity that the Department of
Energy says we need by 2020.
The turbulence in our industry already has caused companies
to cancel or postpone development of approximately 53 gigawatts
of new capacity. And while not all of these cancellations can
be blamed directly on the credit crunch, I am very concerned
about the impact tomorrow of the financial difficulties facing
us today.
I would like to briefly offer my thoughts on what
conditions have contributed to today's difficulties, as well as
what I view as necessary action on the part of industry and
government to initiate recovery.
First and most importantly, we need to recognize that
today's credit crisis is partly the result of a sluggish
economy which has reduced the demand for electricity.
Second, part of our problem is self-inflicted. It would be
disingenuous not to acknowledge that accounting difficulties,
accusations of price manipulation, and inaccurate financial
reporting have contributed to the lack of confidence now being
expressed by financial markets and the financial community. The
actions of a minority have affected the entire sector.
Clearly, our industry must take the lead in restoring
confidence of investors, regulators, policy makers, and
customers in our industry and in the value of competition in
electric markets. We are moving aggressively to restore
confidence on an industry-wide basis by implementing the EPSA
code of ethics and through the work of the committee of chief
risk officers.
On a company-by-company basis, we are shoring up our
balance sheets, reducing debt levels, and making sure we live
by the new Sarbanes-Oxley requirements. These efforts are
essential, and they will continue.
The third and final part of the problem involves continued
uncertainty about the outcome of the public policy debate on
the future of our industry. This committee has asked what
Congress can do to help remove barriers to the flow of capital.
I think there are four areas on which Congress can and should
focus.
First, Congress can help address regulatory uncertainty by
enabling FERC to move promptly to established well-designed
regional electricity markets across the country. In my view,
the minimum requirements for a well-designed market include an
independent grid operator, a real-time spot market with a means
for managing congestion, a minimum resource adequacy
requirement, and a market monitoring plan to assure that all
participants obey the rules.
Second, Congress needs to address the current patchwork of
State and Federal environmental regulations for powerplant
emissions. I am pleased that this topic is on the congressional
agenda. And I encourage Congress to enact multi-pollutant
legislation this year. This system will provide clear direction
on environmental basis and a sound basis on which to make
investment decisions about our facilities.
The third issue Congress needs to address is reform of the
bankruptcy code. One of the realities of the credit crunch is
that some companies will likely face bankruptcy. Our industry
has done a very good job in mitigating counter party risk by
negotiating netting provisions and standard contracts. It is
important that Congress pass bankruptcy reform legislation that
ensures that these contract netting provisions are honored in
bankruptcy proceedings.
Finally, I would suggest two changes to the tax code that I
believe will help spur investment. The first is accelerated
depreciation of generation assets. Companies that build
powerplants should be provided the same treatment as other
capital-intensive industries.
And for any publicly traded company like PSEG that pays
dividends, elimination of the double tax would be a useful and
important investment incentive. I realize this is a
controversial component of the President's economic plan. And I
hope that the debate focuses on the merits of the proposal, and
it goes forward.
Mr. Chairman, competitive power suppliers are responsible
for 80 percent of oil generation capacity added in the past
decade. It is very important that we address the financial
condition of the electric industry now in order to assure that
our Nation continues to be served by reliable, affordable,
secure, and environmental responsible supplies of electric
energy.
Thanks for this opportunity. And I will be pleased to
respond to your questions.
[The prepared statement of Mr. Cassidy follows:]
Prepared Statement of Frank Cassidy, President and COO, PSEG Power LLC
I am Frank Cassidy, president and chief operating officer of PSEG
Power LLC, based in Newark, New Jersey. My company is a competitive
power supplier and a subsidiary of Public Service Enterprise Group, a
diversified energy company which this year is celebrating its 100th
anniversary. We are located within the PJM interconnection, one of the
nation's largest and most successful competitive energy markets. In
addition to New Jersey and the PJM region, PSEG also has generation
assets in operation or construction in New York, Connecticut, Ohio, and
Indiana.
I am pleased and honored to appear before this Committee this
morning to represent my company and the Electric Power Supply
Association.
I want to thank Chairman Domenici and Senator Bingaman for their
foresight and leadership on issues affecting the energy industry. We're
here today to explore the serious financial challenges my industry now
confronts. To put this problem in some kind of context, I've worked in
the electric industry my entire career--more than 30 years. The
financial conditions we are experiencing now are the most difficult
that I can remember.
Mr. Chairman, as you are aware, there is a constant need for
capital to run our day-to-day operations, build new facilities, and
develop new technologies. Many companies, even those that are prudently
managed and producing excellent operational results, are facing severe
limitations on their ability to access capital.
This is a serious problem and one that must be addressed today if
we are to build the 355 gigawatts of new electric capacity the
Department of Energy states we'll need by 2020. The turbulence in our
industry already has caused companies to cancel or postpone development
of approximately 53 gigawatts of new capacity. And while not all of
these cancellations can be blamed directly on the credit crunch, I am
very concerned about the impact tomorrow of the financial difficulties
facing us today.
I'd like to briefly offer my thoughts on what conditions have
contributed to today's difficulties, as well as what I view as
necessary action on the part of industry and government to initiate
recovery.
First and most importantly, we need to recognize that today's
credit crisis is partly the result of a sluggish economy, which has
reduced the demand for electricity.
Second, part of our problem is self-inflicted. It would be
disingenuous not to acknowledge that accounting difficulties,
accusations of price manipulation, inaccurate financial reporting, and
fudged and fuzzy balance sheets all have contributed to the lack of
confidence now being expressed by financial markets and the financial
community. The actions of a very small minority have affected the
entire sector.
Clearly, our industry must take the lead in restoring the
confidence of investors, regulators, policymakers, and customers in our
industry and in the value of competition in electricity markets. We are
moving aggressively to restore confidence on an industry-wide basis by
implementing the EPSA Code of Ethics and the work of the Committee of
Chief Risk Officers. On a company-by-company basis, we are shoring up
our balance sheets, reducing debt levels, and making sure we live by
the new Sarbanes-Oxley requirements. These efforts are essential and
will continue.
The third and final part of the problem involves continued
uncertainty about the outcome of public policy debate on the future of
our industry.
This Committee has asked what Congress can do to help remove
barriers to the flow of capital. I think there are four areas on which
Congress can and should focus.
1. First, Congress can help address regulatory uncertainty by
enabling FERC to move promptly to establish well-designed regional
electricity markets across the country. In my view, the minimum
requirements for a well-designed market include an independent grid
operator; a real-time spot market with a means for managing congestion;
a minimum resource adequacy requirement; and a market-monitoring plan
to ensure all participants obey the rules.
2. Second, Congress needs to address the current patchwork of state
and federal environmental regulations for power plant emissions. My
company has been a strong advocate for national emissions caps with
market-based compliance mechanisms. This system will provide clear
direction on environmental policy and a sound basis on which to make
investment decisions about our facilities. I am pleased this topic is
on the Congressional agenda, and I encourage Congress to enact multi-
pollutant legislation this year.
3. The third issue Congress needs to address is reform of the
bankruptcy code. One of the realities of this credit crunch is that
some companies will likely face bankruptcy. Our industry has done a
very good job in mitigating counter-party risk by negotiating netting
provisions in standard contracts. It is important that Congress pass
Bankruptcy Reform legislation that ensures these contract netting
provisions are honored in bankruptcy proceedings.
4. Finally, I would suggest two changes to the tax code that I
believe will help spur investment. The first is accelerated
depreciation of generation assets. Companies that build power plants
should be provided the same tax treatment as other capital intensive
industries. As an example, Mr. Chairman, facilities in shipbuilding and
the pulp and paper industry are depreciable over seven years. The
chemical and semiconductor industries are on a five-year schedule.
Electric generation assets, however, are on a 15 to 20 year
depreciation schedule. This is a disparity that should be corrected.
And for any publicly-traded company like PSEG that pays dividends,
elimination of the double tax would be a useful and important
investment incentive. I realize this is a controversial component of
the President's economic plan. I hope the debate focuses on the merits
of the proposal and it goes forward.
Mr. Chairman, competitive power suppliers are responsible for 80
percent of all generation capacity added in the past decade. It's very
important that we address the financial condition of the electricity
industry now in order to assure our nation continues to be served by
reliable, affordable, secure and environmentally responsible supplies
of electric energy.
Thank you again for the opportunity to appear before the Committee
this morning. I will be pleased to respond to questions.
Senator Thomas. Thank you, Mr. Cassidy.
Ms. Smith.
STATEMENT OF SUZANNE G. SMITH, DIRECTOR, CORPORATE AND
GOVERNMENT RATINGS, STANDARD & POOR'S
Ms. Smith. Good morning, Mr. Chairman and members of the
committee. My name is Suzanne Smith. I am a director at
Standard and Poor's Ratings Services, where I am responsible
for assessing the credit worthiness of companies in the
electricity business.
Standard and Poor's provides independent financial
information, analytical services, and credit ratings to the
world's financial markets. We do not advocate any specific
industry structures or regulatory and energy policies. I
welcome the opportunity to be here today.
Since partial deregulation, financial conditions within the
electricity industry have been unsettled. The industry-wide
slippage in credit quality that started several years ago is
still continuing. Last year the decline unexpectedly
accelerated as electricity prices fell and access to capital
became constrained.
Today some companies are trying to return to a regulated
cost-to-service model by selling unregulated assets. And those
companies that remain committed to competition are liquidating
assets to shore up their balance sheets. Many are hunkering
down for what could be an extended industry slump. All this
represents a sea change from what had previously been an
industry of strong, stable, and predictable financial
performance.
Ratings for the electric utility industry have historically
been investment grade, mainly because of the existence of
regulation. The introduction of competition into the market and
the increased level of investment in non-energy-related
businesses, funded with high levels of debt, have caused an
overall decline in the industry's financial health. Companies
that are experiencing the most problems are those that have no
regulated business to temper losses and no financial support
from a stronger parent.
In the merchant energy segment, an unprecedented mix of
financial and business risks have led to financial crisis and
credit spiraling downward for some companies. Lower power
prices, trading losses, and excess debt have substantially
driven down cash flow and profitability.
Last year, companies engaged in energy marketing and
trading found themselves without sufficient capital at a time
when they needed more liquidity to fund losses and to meet
calls for collateral. Energy marketing and trading is a
confident, sensitive business. The last of transparency caused
by energy marketers operating mostly bilaterally and relying on
their own models to value energy contracts played a role in the
loss of investor confidence.
The presence of contingent claims in loan agreements and
trading contracts made the situation worse by creating a credit
cliff. Loss of an investment grade rating has required that
some companies immediately put up hundreds of millions of
dollars of increased collateral. When lenders or trading
counterparties are allowed to demand payment or terminate
credit facilities upon a change to non-investment grade, the
result can be a crisis that puts the company on the brink of
default. It is important to note that there are hundreds of
non-investment grade companies that operate normally with
stable outlooks, but they do not have ratings triggers.
Financing practices have also contributed to credit
deterioration. Many generating companies relied extensively on
short-term debt to fund construction or acquisition of assets.
Traditionally, generating assets have been funded through a
combination of equity and long-term debt. Banks and borrowers
expected companies to repay the loans through proceeds from
capital market takeout issues. But today banks realize that the
capital markets are not a viable source of repayment.
A small number of energy merchant companies are fighting
for survival. If these companies cannot refinance the debts
that became due in 2003, they may have to resort to debt
restructuring in or out of bankruptcy. But even companies that
successfully refinance can expect onerous terms and conditions.
Amidst these problems it is critically important to also
note that capital is still widely available for this industry.
For example, in the past 2 weeks, Duke Energy, Virginia
Electric Power, Southern National Gas, NiSource, American
Electric Power have all issued bonds. And last week, Allegheny
Energy and Center Point announced new bank loan deals. Last
week, Standard and Poor's assigned it's A minus rating to the
senior secured bank loan of a company called ITC that purchased
the transmission assets of DTE Energy.
Even though a large part of the industry continues to
perform well, it will take time to restore investor confidence.
The market is capable of working out financial distress, but
there will be winners and losers. Standard and Poor's has
previously stated that a competitive wholesale power market
requires marketing and trading functions. But the industry
needs to improve these functions through increased transparency
and disclosure, improve clearing mechanisms, better regulatory
oversight, and probably the entry of some financial partners.
It is becoming increasingly clear that energy trading
cannot function without a high investment grade rating. Most
investors also agree that resolution of pending investigations
would help investor confidence.
More certainty in the regulation and market structure would
also improve investor confidence. Investors have long looked to
the regulator safety net to provide stability to the industry.
Standard and Poor's views regulation as generally being very
supportive of credit quality, but does not see a trend of
strong intervention by regulations to promote the financial
health of utilities.
Lastly, partial deregulation has contributed to the
financial deterioration of electricity markets by creating
competition in the wholesale markets without corresponding
competition in the retail markets, by not providing adequate
incentives for investment and transmission, and by not
providing clear market rules.
In offering these comments, I reiterate that Standard and
Poor's does not advocate specific market structures or
policies. But as industry analysts, we are available to comment
and offer opinions on whether we see policies as supportive of
or detrimental to credit quality and financial health. And,
therefore, I appreciate very much the opportunity to offer our
perspective in this hearing.
Thank you.
[The prepared statement of Ms. Smith follows:]
Prepared Statement of Suzanne G. Smith, Director, Corporate and
Government Ratings, Standard & Poor's
Good morning, Mr. Chairman and members of the Committee. My name is
Suzanne Smith. I am a director in the Corporate & Government Ratings
group at Standard & Poor's Ratings Services. I am responsible for
assessing the creditworthiness of regulated utilities, diversified
energy companies and energy merchants. Standard & Poor's, a division of
The McGraw-Hill Companies, provides independent financial information,
analytical services and credit ratings to the world's financial
markets. Standard & Poor's does not advocate any specific industry
structures or regulatory and energy policies. Standard & Poor's
welcomes the opportunity to be here today to discuss current financial
conditions facing the electricity sector.
INTRODUCTION
Over the past two years, there has been heightened attention paid
to the financial condition of the electricity industry. There are a
number of reasons for this. Following partial deregulation of the
industry, the electricity sector that has resulted is marked by a
greater degree of disparity in its financial health. An industry-wide
slippage in credit quality that started several years ago (before the
advent of deregulation) is still continuing. Last year there was an
unexpected acceleration of the slippage as electricity prices fell and
access to capital became constrained. Today, credit concerns dominate
the industry's strategic decision-making and the management of its
trading and marketing risk. For some participants, a return to a
regulated, ``cost-of-service'' model is being pursued as a way to
preserve financial health, while others, who remain committed to
competition, are liquidating assets to shore up their balance sheets
and are hunkering down for what could be an extended industry slump.
Some so-called ``merchant energy'' and ``diversified energy'' companies
are struggling for their very survival, while a handful of less-
affected companies are pursuing opportunistic asset purchases and
investments in the sector. All this represents a sea change from what
had previously been an industry of strong, stable and predictable
financial performance.
Historically, ratings for the electric utility industry have been
investment grade (the top four categories of the rating scale, from
``AAA'' to ``BBB'') mainly because they were regulated. In addition to
their regulated activities, some utilities have ``unregulated''
operations. In this competitive side of the industry, where there is no
regulatory safety net, the restoration of investor confidence will
require market participants to work out their current financial
problems. It will also require participants to overhaul their trading
and marketing models, to promote more and better transparency in their
market rules and practices and provide for increased transmission
access and investments.
RATINGS DISTRIBUTION AND OUTLOOKS
Over the last three years, the overall credit quality of the
electricity industry has declined. Today only 2% of U.S. electric and
gas companies are rated by Standard & Poor's in the `AA' category. Two
years ago the percentage of AA-rated companies was nearly 7%.
Similarly, 18% of companies now carry ratings that are below the
investment grade cut-off of `BBB-'. Two years ago, the percentage below
investment grade was only 6%. The average rating for the industry,
while still investment grade, has slipped from `A-' to `BBB+' and is
likely to fall to `BBB'.
The introduction of competition into the electricity market and the
increased level of investment in other non-energy related businesses,
which were funded with high levels of debt, have caused an overall
decline in the industry's financial health. What has most shocked the
business and financial community, however, is the speed at which some
of the largest players in the industry deteriorated in 2002, and the
realization that the road to financial health is a bumpy one.
Since the advent of deregulation, the industry has generally moved
from vertically integrated utilities to a mix of disaggregated
electrical generation companies (gencos), distribution companies
(discos), transmission companies (transcos) as well as integrated
companies. They are not uniform in their financial health. For the
regulated discos and gencos, the overall financial condition has
generally remained stable. In fact, a small number of discos and
transcos actually experienced financial improvement last year. Public
power and municipality-owned utilities have also generally fared well.
Standard & Poor's has observed that electric utility holding companies,
especially those with unregulated generation or energy trading and
marketing operations, witnessed a sustained decline in creditworthiness
in 2002 that began at least three years ago. The companies that
experienced the most dramatic and negative change in financial health
are those that are operating in competitive power markets; companies
that have no regulated business to temper losses and no financial
support from a stronger parent.
ACCESS TO CAPITAL
Many companies operating in competitive power markets have
experienced a severe reduction in capital availability from the debt
and equity markets, and high hurdles in accessing the syndicated bank
loan market. There is no single reason to explain why access to capital
has become constrained. Rather, there has been an unprecedented
collision of negative business and financial factors that have caused a
downward credit spiral and financial crisis for some companies.
Low power prices, trading losses and excess leverage have
substantially driven down cash flow and profitability for the merchant
energy (the uncontracted-for) segment of the electricity business.
Merchant gencos generally earn only marginal revenues and are
characterized by a limited ability to cover their fixed costs. The
weakened economy and incomplete or partial deregulation may also be
contributing factors to a reduction in capital availability, but they
are not as much of a driver as is the overall surplus of electric
generation capacity that now exists in most regions of the United
States. This surplus is expected to remain for the next several years.
Last year, companies engaged in energy marketing and trading found
themselves without sufficient capital at a time when they needed more
liquidity to fund losses and to meet collateral calls. These
developments occurred during a period of increasing regulatory
uncertainty and investigations, and amid a perception throughout the
United States of failures in corporate governance. Energy marketing and
trading is a confidence-sensitive business. The lack of transparency
caused by energy marketers operating mostly bilaterally (one-on-one
with counterparties) and relying on their own models to value energy
contracts may well have contributed to the loss of investor confidence.
This lack of transparency may also have contributed to investor
distrust about the adequacy of disclosure and it made more obvious
company's abilities to manage earnings and valuations. Loss of investor
confidence caused industry stock prices to plummet and virtually shut
many energy companies out of the equity markets.
The presence of contingent liabilities in loan agreements and
trading contracts made the situation worse by creating ``credit
cliffs''. Contingent liabilities exist where the terms of borrowing
change (or repayment is accelerated) if debt ratings or financial
performance, or both, deteriorate below specified levels. In the
electricity markets, ``ratings triggers'' are used extensively by
counterparties as a way to determine collateral requirements. A common
trigger is the loss of an investment grade rating, which required some
companies to immediately post hundreds of millions of dollars of
increased collateral. Thus, where an energy trading company contracts
to provide power to a utility counterparty at a specified time in the
future, the contract will provide that if the trading company falls
below investment grade (and thus may be unable to procure the power for
the utility) that the counterparty post sufficient collateral to allow
the utility to shop elsewhere for its needs. If the trading company has
triggers in a material number of its contracts, its capital can be
quickly depleted. There are hundreds of non-investment grade companies
that operate normally and finance normally--and, certainly, the
majority of them are not expected to default. Yet, if, lenders or
trading counterparties demand collateral or even the right to terminate
credit facilities upon a change to non-investment grade, the result can
be a crisis that puts the company on the brink of default. This is
known as a ``credit cliff.''
Another contributing factor to credit deterioration is financing
practice. Many gencos relied very heavily on the near-term debt
markets, chiefly through the medium of short- and medium-term
construction revolvers, acquisition bridge loans, and ``mini-perm''
loans to fund construction or acquisition of individual merchant energy
plants and portfolios of merchant assets. This departs from the
traditional way in which generating assets are traditionally funded,
that is with more reliance on equity and long-term debt. Banks and
borrowers as near-term lenders expected that their loans would be
repaid within two to five years, mainly from proceeds from capital
market ``take-out'' issues. Standard & Poor's estimates the refinancing
requirement to be $90 billion over the next four years, with about $40
billion coming due in 2003. Today, because of the uncertainties in the
electricity sector, the capital markets are unwilling to invest in
generating facilities and capital markets are not a viable source of
repayment for the banks. Making matters worse, some banks want to
reduce their exposure to the electricity sector and are reluctant to
roll over or refinance outstanding loans. Some companies are deeply
exposed as the vast majority of their capitalization consists of short-
or medium-term bank loans that mature this year or next.
Amid these problems, it is important to note that capital is still
available for many segments of the electricity industry, especially for
the regulated side and for unregulated gencos having long-term
contracts with creditworthy counterparties. Standard & Poor's utility,
energy and project finance group is still frequently asked to assign
ratings to new capital-markets debt issues and bank loan facilities.
Examples of the past two weeks' activity includes ratings for Duke
Energy Corp.'s $500 million of mortgage bonds, Virginia Electric
Power's $400 million notes, Southern Natural Gas' $400 million notes,
and NiSource's $345 million of senior notes. Last week, new bank loan
ratings were announced for American Electric Power, Allegheny Energy
and Centerpoint. On February 26, Standard & Poor's assigned its A-
rating to the senior secured bank loan of a transmission company called
ITC that purchased the transmission assets of DTE Energy. Looking
further back, bond issuance in the fourth quarter of 2002 totaled $17
billion. While this amount represented a decline of 24% from two years
ago, when bond issuance was $22 billion, recent activity demonstrates
that access to capital markets has not been denied to the sector as a
whole.
STRATEGIC RESPONSES
Recently, poor industry fundamentals along with limited access to
capital have caused industry participants to focus on creditworthiness
more than in previous years. Credit issues now influence corporate
strategies in ways that were not previously considered. Companies with
relatively strong credit ratings that were previously willing to make
aggressive moves in the market may now be unwilling to consider
acquisitions because they do not want to jeopardize their access to the
capital markets. However, there appear to be other companies and new
entrants with cash that are interested in obtaining distressed utility
assets.
Increasingly, strategies in the electricity sector are focusing on
debt reduction, balance sheet improvement and scaling back on marketing
and trading and merchant power generation. For most companies, the way
to financial health rests, not surprisingly, through debt reduction by
generating positive cash flow after paying capital expenditures,
interest, and dividends. A common strategy features a return to the
practice of increasing assets in the rate-base and collecting a
regulated cost-of-service return. Some companies have obtained
regulatory orders that transfer previously unregulated merchant plants
into regulated rate-based assets. Companies with merchant asset
portfolios are dealing with the spectre of a prolonged slump by
canceling or renegotiating turbine contracts, canceling projects under
development as well as partially completed plants, and, in a handful of
cases, abandonment of nearly completed projects. Many companies
announced that they were exiting or severely curtailing their marketing
and trading operations. And regardless of whether the company is
pursuing improved cash flow through operations, regulatory relief, or
termination or abandonment, it is also likely to pursue asset sales.
Though Standard & Poor's views most of these strategies as prudent
for maintaining or improving companies' financial health, they are not
the only way the industry may recover. If successfully implemented,
creditworthiness should strengthen. A few companies continue to expand
through acquisitions without a loss in their credit rating.
There are risks, however. Executing asset sales can be problematic
and expensive. Assets sales are problematic because of the timing and
price of the sale, as well as the loss of cash flow that occurs once
the asset is sold. Although gas pipelines and power plants with long-
term contracts are selling briskly, merchant power plants are not.
Sales of international investments are showing mixed results, with many
(Latin American assets, for example) selling at a loss. Additionally,
in some cases these strategies will take several years to implement
before material debt reduction will be realized, especially if the
profitability of merchant plants remains low.
One obstacle that is confronted in any sale of a merchant power
facility is establishing its value. In general, valuations are lower
than was initially anticipated--but by how much? At present, there is
no clear answer. Standard & Poor's anticipates that market comparables
will emerge over the next year as distressed borrowers and their
lenders face decisions on how to handle merchant energy debt. Merchant
plant valuations will need to be established and they will set the
stage for restructuring and consolidation.
Standard & Poor's, along with the rest of the industry, observes
that a small number of energy merchant gencos are literally fighting
for survival due to a lack of market liquidity. Their future rests on
the ability to refinance debt and, as such, their fate depends on the
decisions of bank loan arrangers and syndicates. If these companies
cannot refinance the loans coming due in 2003, they may resort to debt
restructuring, either in or out of bankruptcy. Gencos or other
distressed energy companies that refinance successfully can still
expect onerous terms and conditions, including removal of the ability
to ``term out'' (refinance through a long-term loan facility) one-year
revolving loans, more stringent financial covenants, and commitments to
reduce bank loans over time through asset sales or capital market
issues. Pledges of collateral security are expected to continue. Higher
fees and credit spreads are also to be expected. Again, however, there
are bright spots in the survival camp. In December 2002, AES Corp.
completed a major refinancing which extends by a few years many of the
company's debt maturities. Under current conditions, the market has
viewed AES's refinancing as achievement.
RESTORING INVESTOR CONFIDENCE
Standard & Poor's believes that investor confidence in the industry
may take time to restore, even though a portion of the industry
continues to perform well. Companies have already taken steps to
restore investor confidence by revising business strategies, improving
financial and risk disclosure, making provision for liquidity, and
removing ratings triggers. Confidence should improve when near-term
refinancings are worked out, when the handful of companies that may go
bankrupt do so, when revised strategies prove successful or otherwise
meet their fates, and when banks and borrowers complete the write-offs
of their losses. All of this will take time--at least the next 18
months, and probably considerably longer. The market is capable of
working out financial distress, but there will certainly be winners and
losers.
In several of its publications, Standard & Poor's has stated that a
functioning competitive wholesale energy market requires competent
marketing and trading functions. These functions include robust, deep
and liquid markets offering a range of products and tenors. A
competitive wholesale energy market has proven difficult to establish.
Nevertheless, Standard & Poor's has not moved from its original
position. The restoration of investor confidence depends on effectively
overhauling the existing model for trading electricity. It is currently
unclear how the overhauling process will work out and what, exactly,
will emerge. What is clear, however, is that trading operations,
similar to financial institutions that conduct derivative trading
businesses, require high investment-grade ratings. As noted previously,
this is due to the requirement that energy marketers meet and pay short
term trading losses without suffering material loss of liquidity.
Trading operations at the low end of the investment grade scale (BBB-
range) or at less than investment grade (BB and lower) are not viable
because the dramatically higher capital requirements are an inefficient
use of capital. This fact explains why so many companies have announced
they are either exiting the business or are looking for partners. The
volatility of earnings from trading and marketing make it a business
that cannot sustain high levels of debt.
Restoring investor confidence also relies upon improving investors'
understanding of how risk and credit exposure are measured. Standard &
Poor's believes that a successful overhaul of the trading and marketing
model will require increased transparency and disclosure, probably the
entry of financial partners, improved clearing mechanisms, and better
regulatory oversight. Most investors agree that resolution of pending
investigations would certainly help investor confidence.
Finally, a measure of certainty regarding regulation and market
structure might also improve investor confidence. Investors have long
looked to the regulatory ``safety net'' to provide stability to the
electricity industry. Ratings for the electric utility industry have
historically been investment grade mainly because regulation
traditionally allowed utilities to earn steady and predictable returns
over sustained periods. As a result investment grade rated utilities
have generally been able to enjoy lower cash flow ratios than their
comparably rated industrial peers. Notwithstanding any other benefits
wrought by deregulation, Standard & Poor's views traditional regulation
as generally supportive of credit quality. In recent years, however, it
does not appear that there has been a trend of strong intervention by
regulators to promote the financial health of utilities. A Standard &
Poor's survey of state regulatory commissioners conducted in 2001
indicated that credit quality ranked low on their list of priorities.
Areas of concern include the apparent lack of attention that regulators
appear to give to utilities' nonregulated investments, and the threat
to utility credit quality from their parents' activities and uncertain
rulings. Recent regulatory action to protect credit quality by
isolating the utility from the activities of its parent or affiliates,
such as the example of Westar Energy and Kansas Gas & Electric Co.
appear to be a departure from the existing trend, but Standard & Poor's
notes that the company first had to reach a crisis before regulators
acted.
Partial deregulation has contributed to the financial deterioration
of the electricity markets in at least three ways. First, the example
of California indicates the problems of creating competition in the
wholesale supply business without comparable competition in the retail
side of the business. This mismatch has the effect of shifting business
and financial risk from customers to shareholders and lenders. Second,
unregulated gencos have encountered difficulty competing against
regulated cost-of-service generation where regulated utilities are able
to pass on to customers the fixed costs of generation. The competitive
market, however, is not currently compensating merchant power producers
for their fixed capital investments. Lastly, transmission congestion is
still managed physically. Standard & Poor's believes that economic
incentives to invest in new transmission facilities are inadequate.
FERC's recent ruling to boost returns on transmission investments
appears to create a positive economic incentive for increasing the
transmission infrastructure.
CONCLUSION
In offering these comments, I would reiterate to the Honorable
Members that Standard & Poor's does not advocate market structures,
practices or regulatory policies. As analysts, we comment and offer
opinions upon those structures, practices and policies as supportive of
or detrimental to credit quality and financial health.
This concludes my testimony on behalf of Standard & Poor's Ratings
Services. I will be happy to answer any questions.
Senator Thomas. Thank you very much.
Mr. Sokol.
STATEMENT OF DAVID L. SOKOL, CHAIRMAN AND CEO, MIDAMERICAN
ENERGY HOLDINGS COMPANY
Mr. Sokol. Thank you, Mr. Chairman and members of the
committee. My name is David Sokol, chairman and CEO of
MidAmerican Energy Holdings Company, a diversified energy
company headquartered in Des Moines, Iowa, with approximately
$18 billion in assets and operating in 22 of the United States.
This hearing goes to the heart of the most important energy
issue facing Congress today, the financial crisis in the
electricity and natural gas sectors. This sector is facing its
greatest crisis in over 70 years as capital flees this industry
at an alarming rate.
Among the 25 largest utilities alone, more than $100
billion in market capitalization has been lost in the last 2
years. We have seen a net flow of capital out of utility funds
in 48 of the last 60 months. The uninterrupted outflow over the
last 2 years runs directly contrary to this sector's normal
position as a safe haven in difficult economic times.
Indeed, 10 years ago, individual investors owned nearly 60
percent of U.S. utility stocks. But because of instability and
dividend cuts, that percentage is now one half what it used to
be. In the last 5 years, utility debt ratios have climbed from
54 to 63 percent, raising interest rates across the sector and
causing new infrastructure to be built, if at all, with riskier
and more expensive debt.
As interest rates have fallen 200 basis points across the
board in the last 2 years, utilities costs of funds have
actually risen by as much as 400 basis points over the overall
credit index, whereas historically utilities borrowed money at
a lower cost than other industries.
Between Moody's and Standard and Poor's in the last year
they gave the energy sector 203 credit downgrades and only 6
upgrades, which is more downgrades than the total number of
downgrades for the----
Senator Thomas. I do not think your microphone is on. Mr.
Sokol. Sorry.
Senator Thomas. Could you push your button?
Mr. Sokol. You bet.
Senator Thomas. Thank you.
Mr. Sokol [continuing]. Previous 9 years. Twenty years ago,
more than two-thirds of utilities held A or better credit
ratings. Today that fraction is one-third. Now what does all
this mean? It means that the capital markets no longer see
electricity in the natural gas sector as a safe haven. And
worse, barriers to investment are preventing willing companies,
both in and outside of the industry from stepping forward with
equity investments.
Experts estimate that up to $100 billion in equity capital
is available for this industry, but it sits on the sidelines
today because of regulatory impediments. Indeed, this $100
billion in capital would translate into hundreds of thousands
of new jobs in this sector, if it were invested. Our largest
investor, Berkshire Hathaway, one of the only AAA-rated
companies in the United States, has publicly stated its desire
to invest an additional $10 billion to $15 billion in the
utility sector, if barriers to investment caused by the Public
Utility Holding Company Act were lifted.
The real world impacts of these negative trends are far
reaching. Utility dividends have fallen by more than 20 percent
in the last 3 years. Combined with market losses, the effect on
utility investors has been devastating. In the last 3 years,
more than 170,000 megawatts of planned new capacity have been
tabled or canceled. Some of these cancellations represented
appropriate correction for the over building that was taking
place, but many needed projects are also being suspended.
Moreover, there is significant under-investment in the
transmission facilities also caused by this lack of capital
availability. And it is not likely to be improved soon,
notwithstanding the greatly increased need for redundancy
because of homeland security concerns.
New projects and cancellations make headlines. But rarely
do investors put up a red flag saying: I am not investing. But
that is what is happening today. Ironically, this crisis has
benefitted our company because much of the banking community
has written off the electricity sector as a home to too much
bad debt. As a result, Berkshire Hathaway and MidAmerican have
become lenders of last resort in the industry, propping up
companies through loans and with acquisitions.
We cannot make major equity investments in the electricity
sector, however. But we have made loans to utilities where no
other lender could be found. These loans represent good short-
term opportunities for us. But this is not the way the industry
should be capitalized in the long term.
What then must Congress do? For several years I have
testified before Congress calling for comprehensive national
energy legislation. We almost achieved that goal last year. But
we came up short. But instead of finger pointing, let us look
at the lessons we learned last year, which is that Congress
cannot wait to act until political consensus is reached on
every issue. That merely works to the advantage of those who
take extremely positions in the policy arena or who prosper as
a result of market failures.
This is no longer an exercise in academic policy making,
but rather a critical component of any economic recovery
program. Getting capital flowing back into this industry will
have a direct impact on employment economic development and the
quality of life for millions of Americans, particularly
including senior citizens who depend on utility dividends and
reasonable energy prices.
Congress cannot and should not spend billions of dollars
trying to fix this problem, however. But it can pass
legislation to permit the private sector to make long-term
investments in the industry.
How? First, repeal PUHCA to allow for intelligent
investment. Healthy players must be allowed to invest in
utility assets to stabilize the industry.
Let me give you two first-hand examples. Last spring we
purchased the Kern River natural gas pipeline from the Williams
Company, which had planned to double the size of this critical
piece of Western energy infrastructure to deliver more natural
gas from the great State of Wyoming to Nevada and California.
Williams, facing severe financial distress, could not have
undertaken this $1.2 billion expansion. We did. And the project
will come on line May 1 of this year.
The Kern River employees, communities, and consumers in
four Western States will all benefit. This expansion will bring
nearly a billion cubic feet per day of additional natural gas
to customers in Utah, Nevada, and California, who have already
contracted for this capacity for 15 years. If we had not
committed to buy Kern River, this expansion would not have
occurred. But if Kern River were a wire, instead of a pipe,
MidAmerican could not own it, because of PUHCA.
Another example, last summer we purchased the Norther
Natural Gas pipeline system from Dynegy, who had just purchased
it from Enron. This former Enron subsidiary is now on sound
financial footing. And its employees once again have job
security. In contrast, Enron's Portland General Electric
facility remains subject to bankruptcy proceedings. And no
qualified buyer has stepped forward to PGE. Enron, Portland
General, and even their bankruptcy consultants have all come to
us, encouraging us to bid on Portland General. But because of
PUHCA, we cannot.
Secondly, we must make modest changes to the tax code to
encourage the structural separation of transmission and
generation assets and to encourage new investment in
infrastructure and renewable energy.
Third, enact bankruptcy reform to help reduce counterparty
risks associated with the energy markets. And fourth,
streamline the siting of transmission infrastructure to
facilitate new investment and reliability.
Congress's first goal this year must be to promote utility
investment. You may not be able to resolve every policy issue
facing the energy industry today, but the items outlined above
must be addressed to help get this industry and our economy
moving again.
Thank you.
[The prepared statement of Mr. Sokol follows:]
Prepared Statement of David L. Sokol, Chairman and CEO, MidAmerican
Energy Holdings Company
Mr. Chairman and members of the Committee, my name is David L.
Sokol, Chairman and CEO of MidAmerican Energy Holdings Company, a
diversified international energy company headquartered in Des Moines,
Iowa with approximately $18 billion in assets.
MidAmerican Energy consists of six major subsidiaries: CE
Generation (CalEnergy), a global energy company that specializes in
renewable energy development in California, New York, Texas and the
West, as well as the Philippines; MidAmerican Energy Company, an
electric and gas utility serving the states of Iowa, Illinois and South
Dakota; Northern Electric/Yorkshire Electricity, an electric and gas
utility in the United Kingdom; the Kern River Gas Transmission Company,
operating in Wyoming, Utah, Nevada and California; Northern Natural
Gas, the largest gas transmission system in the country, running from
the Permian Basin in Texas and New Mexico through Oklahoma and Kansas,
and into the entire Upper Midwest; and HomeServices of America, the
second-largest residential real estate company in the country,
operating in 14 states.
I believe that MidAmerican provides a clear example that an energy
company can be large, but still maintain a singular focus on the
customer; diversified in scope and operations, yet concentrated on
business fundamentals; growth-oriented, while resistant to the fad of
the moment.
Mr. Chairman, this hearing goes to the heart of the most important
energy issue facing Congress--the financial crisis in the electricity
and natural gas industries. This sector is facing its greatest crisis
in 70 years as capital flees the industry at an alarming rate. Among
the 25 largest utilities alone, more than $100 billion of market
capitalization has been lost since 2000.
We have seen a net flow of capital out of utility funds in 48 of
the last 60 months and in the few months that saw positive flows, most
were negligible. Most disturbingly, the uninterrupted outflow over the
last two years runs directly contrary to the sector's normal position
as a safe haven in difficult economic times. Indeed, ten years ago
individual investors owned nearly 60% of utilities' stock. Because of
instability and dividend cuts, that percentage has been cut in half
today. The mom and pop investors, ``the widows and orphans'' who
financed so much of this industries' growth for decades, are fleeing
the sector as the risk profile of the industry has increased
dramatically. Even companies that do not have substantial exposure in
areas such as trading and merchant generation have suffered because of
negative perceptions of the industry in general.
What, then, has taken the place of the individual investor?
Unfortunately, in many cases, the answer is debt. In the last five
years, utility debt ratios have climbed from 54 to 63 percent, raising
interest rates across the sector and causing new infrastructure to be
built, if at all, with riskier and more expensive debt.
As interest rates have fallen 200 basis points in the last two
years, utilities' cost of funds has risen as much as 400 basis points
above the overall credit index--whereas historically utilities borrowed
at rates below other industries. When you consider that the electric
and gas industries are the most capital-intensive sectors of the entire
economy, the negative impact of this trend is magnified even further.
Moody's and S&P gave the power sector 203 credit downgrades last
year and only 6 upgrades. This is more downgrades than the total number
of downgrades for the previous nine years. In the two previous years,
downgrades outnumbered upgrades by almost 2-1 and more than 5-1,
respectively.
Twenty years ago, more than two-thirds of utilities held ``A'' or
better credit ratings. Today, that fraction is one-third. Some
retrenchment in the sector was inevitable, as too many companies
followed a ``build it and they will come'' model that ignored the
natural limitations on sector growth that characterize the industry.
Hopefully, the days when energy companies were pressured from all sides
to ``be more like Enron'' are gone and won't soon be forgotten.
However, as long as the sector remains subject to competition and
uncertainty and access to capital remains restricted, we do not see
this negative trend reversing.
What does all this mean? The capital markets see the electricity
sector as high risk. And worse, barriers to investment are preventing
willing companies, both in and outside of the industry, from stepping
forward with equity investments. In this riskier, highly competitive
environment, willing investors must step forward with long-term equity
that can ride out the inevitable fluctuations in the business cycle.
Unfortunately, federal law continues to restrict this.
Experts estimate that up to $100 billion in equity capital
available for the industry sits on the sidelines today because of
regulatory impediments. Indeed, this $100 billion in capital would
translate into hundreds of thousands of new jobs in this and related
industries. Our largest investor, Berkshire Hathaway, one of the only
AAA-rated companies in the United States, has publicly stated its
desire to invest $10 to $15 billion in the utility industry if the
barriers to investment caused by the Public Utility Holding Company
Act--PUHCA--are lifted.
Healthy players must be allowed to invest in utility assets to
stabilize the industry.
The real world impacts of these negative trends are far-reaching.
Utility dividends have fallen by more than 20% percent in the last
three years. Combined with market losses, the effect on utility stocks
has been devastating.
In the last three years, more than 170,000 megawatts of planned new
capacity have been tabled or canceled. Some of these cancellations
represent an appropriate correction for overbuilding, but some needed
projects are also being suspended. Moreover, there is significant
under-investment in transmission facilities, also caused by the lack of
capital availability, and it is not likely to be improved soon,
notwithstanding the greatly increased need for redundancy because of
homeland security concerns. New projects and cancellations make
headlines, but rarely do investors put up a red flag to say: ``I'm not
investing.'' But that is what's happening today.
If we fail to turn this situation around, I fear we will be laying
the groundwork for a repeat of the Western energy crisis. For the many
Senators on this Committee from the West, I hope you will ask
yourselves why an Enron was able to manipulate markets in your region,
but not the markets of other regions. The answer, I believe, is that
the West was dangerously short of both capacity and the infrastructure
to deliver that supply to market. Coupled with the terribly conceived
California market structure, conditions were ripe for anti-consumer
behavior. Adequate supply and sensible market rules have delivered
billions of dollars of savings to consumers in markets such as the
Northeast, Midwest and Texas, with no evidence of significant anti-
consumer behavior.
Ironically, the capital crisis has benefited our company, because
much of the banking community has written off the electricity sector as
home to too much bad debt. As a result, Berkshire and MidAmerican have
become lenders of last resort in the industry, propping up companies
through loans and acquisitions. We cannot make major equity investments
in the electric sector, but we have made loans where no other lender
could be found. These loans represent good short-term opportunities for
us, but this is not the way the industry should be capitalized in the
long term.
What, then, must Congress do?
For several years, I have testified before Congress calling for
comprehensive national energy legislation. We almost achieved that goal
last year, but came up short. Instead of finger pointing, let's look at
the lesson learned from last year: Congress cannot wait to act until
political consensus is reached on every issue. That merely works to the
advantage of those who take extreme positions in the policy arena or
who prosper as a result of market failures.
This is no longer an exercise in academic policy making, but rather
a critical component of any economic recovery program. Getting capital
flowing back into this industry will have a direct impact on
employment, economic development, and the quality of life for millions
of Americans, particularly senior citizens who depend on reasonably
priced energy and utility dividends.
Congress cannot, and should not, spend billions of dollars trying
to fix this problem, but it can pass legislation to permit the private
sector to make long-term investments in this industry.
How? First, repeal PUHCA to allow for intelligent investment. Let
me give you two first-hand examples of why you should: Last spring, we
purchased the Kern River natural gas pipeline from the Williams
Company, which had planned to double the size of this critical piece of
Western energy infrastructure to deliver more natural gas from Wyoming
to power-hungry Nevada and California. Williams, facing severe
financial distress, could not have undertaken this $1.2 billion
expansion. We did, and the project will be completed on time this May.
The Kern River employees, communities and consumers in four Western
states will all benefit. This expansion will bring an additional 900
million cubic feet per day of natural gas to customers in Utah, Nevada
and California, who have fully contracted for that capacity for 15
years. If we hadn't come in to buy Kern River, this expansion would not
have occurred. But if Kern River were a wire, not a pipe, MidAmerican
could not own it--because of PUHCA.
Another example: Last summer we purchased the Northern Natural Gas
pipeline system from Dynegy. This former Enron subsidiary is now on
sound financial footing and its employees once again have job security.
In contrast, Enron's Portland General electric utility remains subject
to bankruptcy proceedings, and no qualified buyer has stepped forward
to own PGE. Enron, PGE, even the bankruptcy court, have all encouraged
MidAmerican to bid on PGE. Under PUHCA, we can't.
Leaving aside for a moment the fact that Enron caused its own
problems with its irresponsible and, at times, outright illegal
behavior, there is a larger systemic issue here. One of the biggest
problems in the market is that when Congress chose in 1992 to expose
electric utilities to competition, it provided no means for assets to
be reallocated when a company does poorly in the competitive
environment.
Federal and state regulators have expansive authority to ring fence
regulated utility assets to insulate them from bad investment outcomes
from parent companies or competitive affiliates. Long-term, however,
you don't want a utility operating under a parent that cannot maintain
healthy finances. You can't just leave the walking wounded out there,
but that's what current law does. Once PUHCA is repealed, it is
important to note that utility mergers and major transactions will
still be subject to FERC, state regulatory and DOJ or FTC approval to
ensure they are consistent with the public interest.
Second, make modest changes to the tax code to encourage the
structural separation of transmission and generation assets and
encourage new investment in infrastructure.
The provisions on separating transmission from generation enjoy
broad support from industry stakeholders as necessary to facilitate the
formation of RTOs. FERC Chairman Pat Wood has testified on a number of
occasions that this is one of his highest priorities in any energy bill
that Congress considers. While this provision carries a budget scoring
``cost,'' there is no real world cost to making this change in the tax
code.
Companies simply will not take a 30 percent tax hit on selling
their transmission assets, so there is no real revenue to be lost by
making this change. The main issue is whether companies are forced to
structure sub-optimal transactions to avoid a taxable event or whether
the law can be changed to accommodate a straightforward spin-off.
Another element of the tax package should include incentives for
socially beneficial energy infrastructure investments. Among the
provisions that should be considered are expanding the production tax
credit to all renewable resources, accelerating depreciation for
investments in new transmission and new transmission technologies, and
accelerating depreciation for new investments in pollution control,
repowerings, and high-efficiency technologies.
Last year, the Senate passed a bipartisan package of tax provisions
related to the electric and gas industries that enjoyed broad support.
These provisions were not highly controversial and would have
encouraged new investment in electric transmission and renewable
energy. Like PUHCA, these tax issues have been around for years, enjoy
broad support, and would send a clear positive message to Wall Street.
Also, while the President's proposal on eliminating the double
taxation of dividends is more of a macro issue and would not have a
major direct impact on MidAmerican because we are a privately-held
company, the overwhelming majority of electric and gas companies are
dividend payers, and enacting the President's proposal would broadly
benefit the industry.
Third, enact bankruptcy reform to help reduce counter-party risk
associated with energy markets. I believe the days of expecting energy
trading to be a huge profit center for a large number of companies are
probably over. At MidAmerican, we have always thought of trading as a
way to hedge risk, not as the means to generate asset-free profits.
However, there is a critical role for energy trading in the
marketplace as a whole. Efficient wholesale energy markets depend on a
liquid trading sector to help match buyers and sellers. While I
understand that bankruptcy reform has been derailed over somewhat
extraneous issues in recent years, the element that is important to the
energy industry is allowing for ``cross-product netting.'' This
provides counter-parties with the assurance that all transactions
between two parties can be safely enforced under a Master Netting
Agreement.
In the earliest stages of the Enron meltdown, I ordered all of our
business units at MidAmerican to review their levels of counter-party
risk and take immediate actions to avoid exposure to potentially
insolvent parties. For individual companies, that's a prudent course of
action. The downside of hundreds of companies each moving to reduce
counter-party exposure is that, in the aggregate, transaction costs are
increased and markets become less liquid. Clarifying these provisions
is a cost-free action that Congress can take to get energy markets
moving in the right direction again.
Fourth, streamline the siting of transmission infrastructure to
facilitate new investment and enhance reliability.
For several years, proposals to give FERC greater authority over
the siting of interstate transmission lines have languished in
Congress. It may well be the case that, at this time, this is simply a
bridge too far. Anything you can do here would be a step in the right
direction. Demands on the transmission system continue to soar while
investment levels are flat or declining. A major cause of this is Wall
Street's fear that a major interstate transmission project can be a
black hole of company time, money and focus. There are important steps
that Congress can take that are less controversial than interstate
siting authority, such as requiring the establishment of joint federal-
state siting boards and streamlining federal agency processes for
siting transmission across federal lands.
Finally, I have serious reservations about legislating on FERC's
Standard Market Design proposal. SMD is neither the regulatory
Frankenstein nor a laissez-faire Dracula that opponents have painted.
Reasonable people can differ over exactly what market design rules
should be, but attempting to legislate them will most likely increase
uncertainty in the markets.
Policymakers need to study successfully working electricity markets
to determine how best to avoid the next California crisis. As I
discussed earlier, a significant factor is creating incentives for new
investment and infrastructure. A second element is applying lessons
learned in well-functioning markets to those that have evident
structural flaws. A third needed component is to smooth out the seams
between regional markets to allow power to flow more freely to demand.
I am concerned that even if Congress could arrive at a conceptual
agreement on how to address issues related to SMD, writing that
agreement into legislative language could be next to impossible.
Moreover, as markets develop, if a provision that was good policy when
enacted needs to be changed down the road, we are all well aware how
difficult making even the most common sense changes in the law can be.
Our electric and gas systems can function under either a
competitive or regulated cost-of-service model, but the existing ``one
foot in the boat, one foot on the dock'' formula has been a recipe for
disaster. The most likely outcome of Congress legislating on the SMD
would be to perpetuate this untenable situation.
In summary, Congress' first goal this year should be to promote
electricity investment. You may not be able to resolve every policy
issue facing the industry today, but the items outlined above must be
addressed to help get this industry, and our economy, moving forward
again.
Thank you.
Senator Thomas. Okay. Thank you, sir. I am interested in
your comments particularly. You have spent some time in
Wyoming, I understand.
Mr. Sokol. Yes, sir, in Jackson.
Senator Thomas. Good.
Let me just ask a question and we will take maybe 5 minutes
each on those. If PUHCA is eliminated, what--do you think that
there are consumers and investors who will be protected? That
is the reason it is there, to keep funny things from happening
between outside investors. What is your reaction to that?
Mr. Sokol. Well, PUHCA was enacted in 1935. And it had, I
think, a very real reason to exist back at that time, when less
than half of the United States even had utility regulation. And
it dealt with some issues, corporate raiding that were taking
place. Today we have a very different situation. Every State in
the United States has a very effective public utility
commission or public service commission. The industry is
clearly regulated, both very effectively at the State level but
also through the Federal Energy Regulatory Commission, the SEC,
the Justice Department, as well.
But what is really important to recognize is that PUHCA
today really does not protect consumers. And in fact, the
Oregon Public Utility Commission recently filed documents with
the SEC saying that PUHCA will in fact harm the consumers in
the State of Oregon, because it will not allow them to operate
that utility in a way that they believe is in the best interest
of consumers.
What has happened over the last 65 years with PUHCA is that
today we have some 5,000 very capable State regulatory
employees, who are in fact protecting these assets. And yet
people think that the mirage of 24 employees at the Securities
and Exchange Commission in the PUHCA section are in fact doing
that job. The reality is the States are doing it. But what
PUHCA is doing is keeping, in our case, a AAA-rated company
from investing in this sector.
Senator Thomas. The States really do not have any authority
over some kind of merger between companies that are in
interstate commerce, right, merchant companies?
Mr. Sokol. They do in regard to how those assets--as an
example, when we purchased MidAmerican Energy, the utility in
Iowa, they placed, the State of Iowa placed, restrictions on
the capital structure, rate-making procedures, and every other
element of that acquisition, or they would not let it go
forward.
Senator Thomas. What if the company that is purchased was
in another State?
Mr. Sokol. I am not aware of any State that does not impose
capital restriction requirements, et cetera, on their utilities
in an acquisition.
Senator Thomas. Okay. You mentioned, sir, that the
committee and the Congress should do something. Specifically,
what do you think are the couple most important things the
Congress could do?
Mr. Svanda. Still on PUHCA reform or----
Senator Thomas. No, just in general.
Mr. Svanda. Okay. I believe that the list of items that I
mentioned to incent investment would be the number one
priority. I agree with nearly all of the comments made by the
other people on your panel with regard to that being the
highest priority. And it would certainly be where I would
focus. And the list of items that would incent investment would
be the first item.
I think with regard to PUHCA reform, certainly reform is
appropriate, so that investment is not deterred where it is
appropriate. But as I mentioned in my oral comments, it needs
to be done in a way that is sensitive to the lessons learned
over the last couple of years, open access to information,
assuring that States and other market monitoring entities have
full access to all of the information that they need to make
good assessments.
Senator Thomas. If one of the reasons for the difficulty is
access to transmission, is being able to move the power to the
markets and so on, it does not look like incentives to invest
would by itself be the answer.
Mr. Svanda. I think that incentives to invest across the
board in a balanced way that focuses on the need for
transmission in many areas of the country, as documented in the
Department of Energy's report on transmission, the $55 billion
plus of investment that is necessary today, and that does not
take into account economic growth when the economy turns and
begins to move and those kinds of things, as well as balanced
investment over into additional generating facilities where
there are load pockets. And to enhance the technologies
utilization of diversified fuel mix across the country are also
important components.
Senator Thomas. So the idea of incentives that could be
provided here need to be aimed at different things, need to be
aimed, for instance, at increased capacity and transmission,
interstate transmission. So just the idea of depreciation, for
example, would not by itself point where we want to go, would
it?
Mr. Svanda. I think that--no. I agree with you, Senator,
that just across the board depreciation relief would not focus
on those other national objectives that are really important
that we worked to accomplish.
Senator Thomas. So we need pretty much a policy and then
follow it up with incentives to initiate and implement that
policy.
Mr. Svanda. That would be my suggestion, yes.
Senator Thomas. I see.
Senator.
Senator Bingaman. Thank you very much.
The main regulatory activity that is going on right now
affecting this industry in a very direct way is the standard
market design proposal that has come out of the FERC. And I
understand they have been taking comments. They are going to
issue a white paper in April.
I think one theme that I heard from almost all of you,
maybe all of you, is the need for more certainty in the
regulatory environment in order to restore investor confidence.
That is one of the justifications offered by Pat Wood at FERC
for propounding the standard market design: that it will give
people some certainty and consistency about what the rules are.
And, I would just ask maybe each of you to comment as to
whether you believe that, as a general matter, FERC is correct
to be trying to enact or put in place a standard market design
like this and whether it will achieve that and benefit the
industry as a result.
Mr. Sokol.
Mr. Sokol. Senator, let me say that I think a standard
market design that is developed through the FERC in cooperation
with the States is a long term and an essential element to the
infrastructure of this country on the energy side. If we had a
comment for FERC, it would be to do it in a very cooperative
fashion with the States, because there are certainly State
issues that have to be coordinated effectively. But the reality
is the transmission system in this country is unlikely to get
the adequate investment that it needs without the limitations
of PUHCA being dealt with and a set of rules established that
both the States and the Federal agencies are in coordination
with.
Senator Bingaman. Do you believe both are important things
to try to accomplish, the repeal of PUHCA and some adoption of
some standardized rules and regulations?
Mr. Sokol. I believe they are. I would caution only that
with respect--that that should be done in a regulatory
framework versus a legislative. Because whatever those rules
are that the States and FERC agree with are going to change
over the next 20 and 30 years. And legislation is very
difficult to modify, where properly executed regulation, I
think, is, in our view, the more appropriate place to do it.
Senator Bingaman. Ms. Smith, did you have a point of view
on this?
Ms. Smith. Well, I basically agree with the other comments
that the market would benefit from a comprehensive market
design and more regulatory certainty. I think particularly in
the sense that it might increase investment in transmission,
which is really where the acute investment need is right now.
You know, overlooking overall standard market design from a
credit perspective, there probably would be some segments of
the industry that might benefit and some that may, you know,
suffer some losses. But overall, I do not think we see that
standard market design in itself is a major credit driver for
any of the companies in the industry right now.
So I think overall it is a benefit, but we do not see it as
a driver in credit.
Senator Bingaman. Okay.
Mr. Cassidy.
Mr. Cassidy. Senator, I was careful in my testimony not to
use those three little words, standard market design. But I did
say that number one on my list is enabling FERC to put in place
well-designed regional markets that have the characteristics
that I outlined. And I do think that would go a tremendously
long way towards shoring up confidence in the future of the
industry.
A number of my colleagues on the panel have talked about
transmission investment. I just note that one of the
characteristics of a well-designed regional market that I
mentioned is a real-time spot market with congestion
management. And what that congestion management piece means is
that price signals are sent that tell investors where to make
investments in the transmission system, so that a well
functioning market provides its own incentives to build new
transmission.
Senator Bingaman. Very good.
Mr. Silverstein.
Mr. Silverstein. Yes. Notwithstanding everything else, I
think part of the problems in the competitive model was seen
that we did not attack transmission first and develop a strong
and liquid transmission grid by which we have some idea of how
electricity, which is a very complicated commodity, moves and
understands the costs of moving it. And I think we went around
this backwards, quite frankly, by opening up generation before
we had approached the transmission problem.
I really think an independent transmission network,
regional as it starts out, is critical to get the most
efficient structure that we can have and, as I said in my
testimony, under any model that we adopt.
I think a real issue that concerns me is the current
conflict between States and Federal Government, because there
is a lot of self-interest involved. And for some generation
plans, that would benefit. Others would be penalized, when the
transmission system is operating on a most efficient way. And
so there are a lot of conflicts that are going on. But for the
good of the overall country, a regional transmission system.
As far as investment, there was some reference to that. I
think transmission should be our first focus. It really needs
to be. There is a fair amount of generation around right now.
Certain pockets need generation. But we have to get this
transmission issue right in order to have everything else be
supported.
And a final comment, if I could, on PUHCA. I do not know if
full repeal is what is necessary. But one aspect of PUHCA,
which is indicative of the problem, is, on one hand two
companies that are not interconnected are restricted from
merging by PUHCA requirements, which is needed for efficiency.
On the other hand, market power is a restriction of two
companies that are in the same markets of combining. And so
there is a conflict between what we need to do and what PUHCA
says we cannot do. And there is a court case on the AEP
situation that exemplifies that. So I think we have to look at
PUHCA and what it is restricting and solve for the issues.
I think when we start with this, what are we trying to
solve for? And we have to have an idea of where we are going
before we start doing piecemeal actions, in my view.
Senator Bingaman. Mr. Svanda.
Mr. Svanda. Senator, as you might imagine, the State
regulators have spent a lot of time thinking and working on
this issue. And I need to first of all say that I need to give
you a slightly schizophrenic answer. In Michigan, we have long
been supporters of a move toward a standardized market. And we
think the lessons of making all the railroad tracks the same
gauge across the country is applicable here. We think that
there are electronic versions of that same innovative approach
of standardization, and that it would be beneficial to the
electricity marketplace as well.
We, Michigan, exist in a region that has generally taken
that approach. And we point to Michigan and Indiana as a great
example of how States with very different perspectives on
retail open access come together on the issue of wholesale open
access. And Indiana presents a State that has firmly committed
to not moving to retail restructuring. Michigan has firmly
committed to retail restructuring. And yet the two States are
hand in glove on the issue of open access and standard market
design development. So we are very supportive in our region and
join other very good regions of the country in that support.
Now I become schizophrenic because I am also here as the
president of our national association. And the regions, for a
lot of different reasons, and I have developed a pretty
exhaustive list of why the regions of the country are
different, how they are different, the fact that the regions
did grow up with different institutions and different economic
mixes, and a whole listing, as I said, of differentiators
across the regions. And so for that reason, as NARUC's
president, I need to let you know that NARUC has not taken a
position with regard to standard market design, that there are
regions of the country and States in the country that are very
supportive. And equally, there are States and regions that are
not supportive.
And so as president, as I have tried to blend those two
positions on the spectrum, I guess what I have become is an
advocate of regional differentiation, that there are real ways
to accommodate free wholesale markets and open access to the
transmission system and still to respect the regional
differences and the State differences that exist in the
country.
Senator Bingaman. Thank you very much.
Senator Thomas. Thank you.
Let me follow up just a little bit on that. In order to do
it regionally, there have to be functional RTOs I believe. And
that is not necessarily the case yet. How do you provide an
incentive for that?
Mr. Svanda. I think functional RTOs or some equivalent in
the Western States, for example, Senator, there have been great
efforts historically from governors of that region and other
political leaders, as well as the institutions themselves, to
establish many of the mechanisms that we today recognize are
critical parts of RTOs.
Now there are also components of RTO development that need
work across the country. And I think there is a real
recognition, for example, with regard to market monitoring,
that it is an area where States and RTOs and the FERC and
others share a common interest in assuring the strong
development market monitoring mechanisms. So it is an area
where we can all work, in spite of the fact that in the Midwest
we have the Midwest ISO and PJM working to be the RTO in the
West.
There are different structures in the South and Southeast.
There are different structures still in the Northeast corner of
the country. In fact, just a couple of days ago, the Northeast
initiated their version of a standard market design system
across the northeastern States.
Senator Thomas. Well, that is one of the reasons we had
problems trying to put something together last year, is the
different regions that had the same industries felt quite
differently about the solution. And then you throw into that
particularly the Bonnevilles and the public powers, who did not
want to integrate particularly with their transmission into the
investor owned. Then you have a real standoff. And we need to
find a way to resolve that.
Mr. Svanda. And, Senator, that is why I suggest that
respect be given to those regional differences in the
institutions that work well for them.
Senator Thomas. Exactly.
Mr. Svanda. I do not see that as a fatal impediment to the
development of a standard market design. I have long said that.
And I believe and I am hoping that FERC white paper in April
will also reflect some of that type of thinking.
Senator Thomas. There has to be some independence.
Mr. Silverstein. You talked quite a bit about investment in
the transmission. Who do you--who should have the ownership of
that? I mean, transmissions have traditionally been put into
place by the power providers and the generators who are not
excited about having other people on there. And if you have a
third-party operator, where do you get the investment? How does
that work?
Mr. Silverstein. Well, I think right now a transmission
type of investment is perceived as a very attractive investment
for the capital that is out there. The capital that Mr. Sokol
suggests is out there, which it probably is. And Suzanne talked
about there is capital coming into the industry.
They want to invest in stable infrastructure investments.
KKR just invested in a transmission line in Michigan. In this
very uncertain and risk adverse time, that is one of the
investments they are willing to invest in. What we need is some
certainty.
Senator Thomas. Why have we not investment in it then, if
it is so attractive?
Mr. Silverstein. Well, it is just beginning. One of the key
issues on the sale price is the tax issue. There is a tax
exposure to the seller. There is tax leakage. And they wanted--
there are some suggestions about some tax modifications to give
them an incentive. FERC just provided incentives to move
transmission into independent hands on a return equity basis.
And I think this is going to start to move the process along.
You know, this is an evolutionary process. But I do believe
there is capital available for transmission investment. In my
view, transmission looks like a lot like what the traditional
integrated utility model looked like years ago, when it was
considered a very stable, low risk investment.
So I think the capital is there. We just need to set policy
incentives.
Senator Thomas. My question is: Who is going to be the
third-party operator?
Mr. Silverstein. Well, the third-party operator is probably
a utility type or some other type of management that is totally
independent of either the generation or the distribution. There
are plenty of engineers and companies that will operate
transmission. We have to demonstrate that they are capable of
operating transmission. I do not think that is really the
issue. The issue--to me, RTOs were always an interim step to
the ultimate goal of having the totally independently owned and
operated transmission system. I believe if we were setting up
this model from scratch, that is the way it would be. The
problem is this model is a legacy model that we are trying to
transition to. And that is what is creating all the problems. I
do not think there is an issue of----
Senator Thomas. But the fact is, and the reliability
council indicates, that for the next ten years there is only
projected of 10,000 miles of additional transmission. And we
have 160,000 miles. That is not likely to keep up. I mean,
there is no indication that what you are talking about as
investment is taking place.
Mr. Silverstein. Well, I do not think it is because the
capital is not there. I think there are impediments on building
transmission. The focus has been on generation. I do not think
that looking at what the plan is indicative of what the reality
is. I think transmission capital is available. This is--the
capital is not coming into the industry now to invest in
merchant.
Senator Thomas. But what happened, as you know, is the
generators have been now gas fired, small generators built
close to the market to avoid the transmission question. Were we
in the coal business, we would love to transmit electricity.
But we have not had an opportunity to have transmission.
Mr. Silverstein. I can respond to that in that some of that
generation that you said was built close to the market is not
close to the market. That undisciplined capital built
generation in a lot of places that are not going to access
markets because the transmission constraints are there and are
not available.
Senator Thomas. But they are small. They are 100 megawatts
or something.
Mr. Silverstein. I mean, but I just think the impediments
of not being able to get transmission sited, as you know, has
really been the major constraint.
Senator Thomas. Right.
Mr. Silverstein. When you look at what you are talking
about, constraints, we have to look at all the solutions,
whether it is transmission, generation, distributed generation,
conservation. In my testimony, that is why I talk about all
those options have to be looked at to solve the problems. In
not every case transmission is the answer. In not every case
generation is the answer. There should be multiple solutions to
every problem. And it is a decision that we have to make as to
what that solution is, but not on a broad scale individually.
Senator Thomas. Okay. Thank you.
Senator.
Senator Bingaman. One of the things we encountered when the
crisis hit in California and the west coast was the buyers of
power were having to essentially sign on to very high-priced,
long-term contracts, or did sign on to high-priced contracts.
And some of them are still trying to figure out how to get out
of those.
Now that power is cheap, do you have buyers going into the
market, and are they able, under these circumstances, to lock
in long-term supplies of power at low prices? I mean, that is
something I would think would be happening and would be a good
thing from the point of view of consumers and companies that
need this electricity.
Mr. Cassidy, is this happening, or am I--it just seems to
me there is some logic in thinking it would.
Mr. Cassidy. I agree with you, Senator, that there is logic
to thinking that it would. And I would tell you that those of
us in the generation and marketing sector are more than willing
to enter into long-term contracts, because that provides us a
level of financial stability that we would not otherwise have.
I would say that on the consuming side, that we have seen
less of that than I would have expected. And I think it may
have to do with issues concerning just being gun shy from
things that have happened in the market in the past.
Senator Bingaman. Any of the others have any comments?
Mr. Sokol.
Mr. Sokol. Yes. What you are saying would make perfect
sense and one would think it would happen. But in an industry
where there is a lot of breakage and there are a lot of
uncertain rules, what you saw happening up until California got
into trouble, no one wanted to enter into any contracts. We had
power available to sell into California prior to 2000. And the
utilities would not even talk to you.
The reason was prices were low. They thought they would
stay low. The supply-demand imbalance occurred. People wanted
to rush to make sure they would have adequate supplies. So they
signed long-time contracts. A natural response occurred. More
generation came on line. Prices came down. And today you do not
see them signing long-term contracts. It is--there are a lot of
perverse incentives out there that are creating some pretty odd
situations.
But to speak to your question at the introduction, we do
have, I think, an excess of supply of generation in most parts
of the country today, in some parts a significant oversupply.
But there is no investment going on. And there are dozens of
plants that have been stopped mid-construction. One that I am
aware of, a thousand megawatt plant, was stopped 70 percent
completed.
So there is a real shifting set of dynamics. And if the
economy does pick up steam and utilization of energy goes up,
coupled with natural gas prices and the reality of the natural
gas industry today, it will not very long in the future that
you will be holding hearings on why are electricity prices so
high again.
Senator Bingaman. That has been a concern. And I tried to
sort of allude to that in my opening comment about us having a
hearing on the supply situation because when you look at the
price of natural gas, where it is today, and you look at the
lack of rainfall in the Northwest, and the lack of
hydroelectric power coming out of the Northwest, it sounds like
the same set of circumstances are coming into place that caused
some of the crisis on the west coast a couple of years ago.
I mean, I think what we are seeing here is you are not
seeing people going ahead and signing on to long-term contracts
as purchasers. It is a little like the way we deal with the
SPRO around here. There is a big push to fill the Strategic
Petroleum Reserve once the price the oil gets high, because
people realize that this is a valued commodity and one we need
to have a bunch of. And when the price drops down to $10 or
$12, as it did a few years ago, you cannot get anybody
interested in filling the SPRO because they assume it is not a
big deal; there is plenty of it around.
Mr. Silverstein, did you have a comment?
Mr. Silverstein. I think it is three things. And one is
human behavior, which you just described, that it seems like
prices have to start going up before you incentivize people or
get them to respond to long-term contracts. It happens in
mortgages. When interest rates go up, there is a rush to do
mortgages.
I think it is the general uncertainty of the environment.
And I think it is the credit quality concerns on the part of
providers of the power, that there were contracts that were
signed with providers in these last couple years that had to be
broken, because they were not truly supported by economic and
financial strength behind these companies.
So we have this uncertainty and this risk adverse. What we
are starting to see, because the gas prices go up pretty
substantially here in the last three months or so, and if that
continues, I think you will see buyers of power or purchasers
of power starting to push towards signing longer term contracts
to lock in the low cost supply.
Senator Bingaman. Mr. Svanda, did you have a comment?
Mr. Svanda. I did, Senator. And your interest in the
description of long-term contracts is exactly what we are
experiencing in Michigan. We have had, over the past couple of
years, more than a couple thousand megawatts of new merchant
plant development. And we have additional probably 3,000
megawatts of merchant plant coming on line fairly shortly,
including some very significant plants up to 1,100 megawatt in
size generating plants. And they are based on long-term
bilateral contracts and arrangements with third parties for
marketing and those kinds of things.
So it, again, is one of those areas where, I think if you
build the crutch kind of harmonized regulatory climate from all
of the parties involved, that you can incent investment and
encourage it to move forward.
I think that ties into the question that you started
initially with, and that was are we building enough on the
supply side. And I do think that work needs to be done there.
As I mentioned in my comments, the demand for electricity is
down considerably with the slowed down economy. We are not
testing our system at all.
If we were in fact experiencing a robust economy today, we
would be wondering why we had not taken advantage of the time
available to us to invest and build transmission and generation
support and environmentally sensitive and diversified fuel
sources to support that vibrant economy.
Senator Bingaman. Thank you very much.
Senator Thomas. Welcome, Senator Johnson. Would you care to
make a statement or ask questions?
Senator Johnson. Thank you, Mr. Chairman. I will submit a
statement. I apologize for being late to this hearing. I, as so
many members do, I have just a lot of things going on
simultaneously here. And I will submit a statement for the
record.
Senator Thomas. It will be put in the record.
[The prepared statement of Senator Johnson follows:]
Prepared Statement of Hon. Tim. Johnson, U.S. Senator From South Dakota
Mr. Chairman, thank you for holding this important hearing today.
This is a difficult and critical time for electricity providers and
the energy industry. Our economy and the nation is directly reliant on
a healthy electricity system. Our providers do a great job of keeping
the country wired and bringing power where is it is needed. Providing
affordable and reliable power to consumers has been one of the biggest
reasons that the nation has progressed in the last century. In my part
of the country, the electrification of rural areas in the early to mid-
1900s literally brought the modern world to these spots and enabled
states like South Dakota to grow and prosper.
However, it is clear that this is becoming far more difficult. The
demand for electricity is growing rapidly, faster than most providers
can keep up with it. The blackouts in California, the collapse of
Enron, some failed investments and the slow economy have adversely
affected utilities and other electricity providers. Moreover, the
entire energy system is strained. The increasing volatility in gasoline
and diesel prices, the growing tension in the world from the terrorist
attacks, and the possibility of war with Iraq have affected all of us.
It is clear that we need to bring stability and more certainty to the
situation so that we don't face shortages and blackouts in the future.
Our economy depends on it.
The main issue facing utilities and other electricity providers is
the lack of access to capital. Many are reluctant to invest when there
is so much uncertainty in the future. Perhaps nowhere is this more
acute than in the transmission system. In many parts of the country,
the transmission system is balkanized and literally maxed out. The
constraints cause more pressure and can lead to blackouts and people
not receiving the power they need. Improving the ability of the
transmission system to move power from one area to the next is the key
to making the system improve with the demands of the 20th century. We
need to search for ways to encourage more building of transmission, and
for the creation of innovative technologies to move power. As demand
grows, so does the need for a modern system to handle the nation's
needs.
Congress has looked at many options to aid the system and more will
likely be considered as part of an energy bill or as stand-alone bills.
These are very difficult and complex problems that we are addressing.
It is important that all parties and regions participate in the
discussion and work toward solutions that benefit everyone. The nation
depends on a stable and modern electricity system and everyone must
work together to maintain that goal.
Senator Johnson. Let me ask just briefly, however, to Mr.
Sokol, I noticed in your full investment agenda that you
included extension and expansion of the renewable energy tax
credits. Is that something that is of interest only to the
renewable side of your business, or does your utility see value
in that, also?
Mr. Sokol. Thank you, Senator. Our utility does see value
in that. To be fair and honest, it predominantly driven by the
States that we operate in as a request of the magnitude,
because currently that production will cost a premium. But we
do think that, as a broader analysis of the generation mix, it
makes sense to have as much renewable as is reasonably
affordable.
Senator Johnson. Let me ask Mr. Sokol or any other members
of the panel who would be so inclined, a concern I have about
attracting more investment into transmission systems, how can
we assist with that? And also the connected question of whether
the lack of investment affects the ability to create new
technologies for transmission, and whether that is in fact one
of the consequences of the lack of our inability to attract
capital right now.
Mr. Sokol. I think just to start a comment, the chairman of
NARUC, who is here, made a comment earlier that one way is, and
it is a great term, harmonizing State and Federal regulation is
probably the most significant issue for transmission
investment.
Secondly would be an issue that I sound like a broken
record on, but PUHCA limitations, which is you have to allow
people to own more than 4.9 percent of something, or you will
not find the level of investment that I think you are looking
for.
But the harmonization of State and Federal rules, whether
that is a cooperative or regional SMD or some other process, is
essential, I think, for this industry.
Senator Johnson. Any other comment on that issue?
Ms. Smith. I would just say that some of the incentives
that have been structured recently with independent ownership
of transmission are, from a credit perspective, are good,
because they do offer predictable, reliable returns for
transmission owners and probably would be a good incentive for
investment. A comment has been made already that the
constraints for investment is probably not capital constraint.
And I agree with that. It is not a shortage of capital. It is
really a question of siting is one of the bigger issues.
Senator Johnson. Mr. Silverstein.
Mr. Silverstein. I just think independent transmission, if
it is in the hands of independents, there is a better shot of
those owners being in different technological achievement and
investment. Because they are in the business to make that
system as efficient as possible, indifferent to what it does to
the generation side of the business. And that is why I believe
under any model transmission is better off in independent
hands.
Mr. Svanda. Senator, I would just speak to your interest in
technological development and investment. And in earlier
comments I did make the claim that that is one of the most
important things that we could be doing, that we do have, as a
national grid, a fairly dumb system based on mechanical
switching systems out of our industrial past, and that we do
need to be upgrading. We need to make that system smart for
reliability and homeland security and a lot of other reasons.
And there is not any better way than investing in technology.
There also is not any better way to take advantage or
rights-of-way and other constrained land areas than by
intensifying the utilization. And we can only do that through
technological advance.
Senator Johnson. Right.
Thank you, Mr. Chairman.
Senator Thomas. Thank you, sir.
Commissioner, let me say that some utilities have described
the dilemma they face in satisfying State regulators and the
Federal Regulatory Commission. And this tends to undermine in
their view some of the costs of recovery. The Supreme Court, as
you know, is hearing a case of Louisiana Public Service
Commission. To what extent do you think the State rate makers
authority has to do with financial distress and resistence to
investing?
Mr. Svanda. Well, certainly State regulators--and as I
indicated with your earlier comment--can contribute
significantly to harmonizing the total environment that we
operate under. We can--we can ask the State regulators across
the country to meaningfully ensure that they are contributing
to stability and an investor climate that is appropriate. We
cannot predict how they will respond as individual
commissioners or as individual States to that appeal.
But the issue has been elevated for every State
commissioner across the country in terms of the importance of
representing a stable and reliable environment for investment.
One of the fortunate experiences that we, as State regulators,
have is that we do view the capital markets from a few
perspectives, including this one and telecommunications. And we
see some real similarities in terms of how investment patterns
have developed recently. And I think we are serious across the
country.
Senator Thomas. I guess my question is, have they been part
of the obstacle to moving forward? Have regulators been part of
the problem?
Mr. Svanda. In truth, yes, regulators can be part of the
problem. They can also be part of the solution. It depends on
how they approach their particular job.
Senator Thomas. Okay. Good.
Mr. Sokol. If we get rid of PUHCA, PURPA, do we have
sufficient resources and organizations to outlaw the practice
of round trip trading, false information, which is something
that apparently has been happening, at least in the west coast
system? Do we have adequate price and transmission visibility,
openness? What do you think?
Mr. Sokol. Well, I think there are two different questions
there. In fairness, I would argue, Mr. Chairman, that PUHCA has
nothing to do with any of those items. And I think in truth it
does not.
I would respond to an earlier comment or question that you
had asked. Customer and consumer protections, those that do
exist in PUHCA, from our standpoint and I think from the
industry's standpoint, should be kept, whether they are kept as
a revised PUHCA or in some other area. Because if the State
regulators have access to books and records and proper
availability of information, I think in the 14 States we
operate in, they do a very effective job of regulating.
As far as round trip trading and that, as a company, we
think that the derivatives industry and the energy sector
should be regulated. Trading should be regulated, just as the
financial trading industry is. I think a great deal of the
chicanery and nonsense and illegality that took place would
have been avoided if, in fact, there had been both oversight
and the fear of retribution or penalty.
So--but PUHCA certainly did not stop Enron from doing what
they were doing or we are doing or a number of other players.
And----
Senator Thomas. Well, but the question is: If you have
investment that is around different places and so on, PUHCA,
you have some potential to do some things that are unusual.
Mr. Sokol. True, although I would point out that of the
Enron assets that have any remaining value, they were those
assets that were protected by either State or Federal
regulation, which are their pipelines or their utilities.
Senator Thomas. Ms. Smith, I think you indicated that you
thought more regulation was better than the marketplace. Is
that what----
Ms. Smith. Well, I was making the point that for credit
quality, where regulation provides a predictable return, that
is good for credit. But in terms of whether more regulation is
necessary, you know, I think it would be in many cases better
to have more for----
Senator Thomas. Well, that, of course, is--this is the
whole situation as to where we are. We came from a regulated
industry, totally regulated industry. And now we are finding
one where generation, at least, is no longer regulated. And we
are going into a marketplace. And so do we not have to deal? I
think if we want to be in a marketplace, which I suppose most
of us do, then do we not have to deal with that?
Ms. Smith. Absolutely. I think you have to look at having
clear market rules, probably better oversight of the regulatory
system. I mean, what we are saying is that the marketing and
trading function, in particular, needs to be overhauled and
would benefit from better oversight. That is one part of it.
There are other, you know, overhaul issues, I think, that are
related to that. But oversight is one of them.
Senator Thomas. Someone might suggest that, frankly, we do
not have much of a policy, number one, which we should have.
And number two, our currently regulatory thing has not kept
pace with the change in the industry.
Ms. Smith. Right.
Senator Thomas. We seem to be resistant to doing that, even
though the changes have taken place to a large extent.
Ms. Smith. We have also noted that, you know, regulators
generally have the jurisdiction and the authority to take
actions, particularly on a State level. But they have been
reluctant to do that. You have situations, like in California
and Nevada, where I do not think--where the regulators could
certainly have acted, but they did not. Or similarly in the
State of Minnesota, with the situation with Excel Energy and
NRG, you know, maybe now the regulators are looking at trying
to protect the utility from the activities of its unregulated
business component. But a crisis really had to occur before
that took place.
So there is a question of whether the regulation is
preemptive or reactionary. I think more preemptive regulation
would benefit credit quality as well.
Senator Thomas. Most of us want a minimum of regulation,
but it has to be enough to do the job. And we certainly come
from an industry where the generators and their distribution
systems were all integrated. And there was much less
regulatory, intrastate regulatory, things that had to happen.
Senator.
Senator Bingaman. Yes. Let me just question on this. Mr.
Sokol, you have indicated that were it not for the existence of
PUHCA, you would be perhaps interested in looking at purchase
or acquisition of the Portland General Electric Company, or at
least that is a possibility. So PUHCA is keeping you from doing
that. And I understand your point of view, and I have agreed
with you that PUHCA has outlived its usefulness in that regard.
But those who oppose the repeal of PUHCA say that without
PUHCA Enron would not have just owned PGE, Enron would have
owned 10 or 20 utilities around the country. These guys were
highrollers. They had a stock price that allowed them to buy
anything they wanted, essentially. So what do you believe we
would have to put in place to properly guard against that
circumstance of a company coming in, a company that did not
have the financial soundness to be doing that, and wind up with
a whole lot more in-stress utilities at the end of things than
we have under what happened this time?
Mr. Sokol. Well, I think two things. First of all, Enron
was actually trying to sell Portland General for 2 years prior
to them going bankrupt. And the reality was they were trying to
leave an asset heavy industry. But the reason Portland General
still exists today as a utility and has its own financial
capability is the fact that the State ring fenced Portland
General from the rest of Enron and required that it stay that
way.
None of the States that we operate in would handle that any
differently. I mean, they required--and in fact the State of
Iowa, even with Berkshire as the 80 percent economic owner,
required the same thing, that that utilities capital structure
be rigidly established.
I think that between the Justice Department and the FTC
under the same provisions that any other industry would
consolidate under, which would protect for market manipulation
or excessive market power, you would have those today in the
United States as we have for every other industry. So from the
standpoint of a company acquiring two or three, I think the
protections, other than PUHCA are the existing Federal
requirements for antitrust and then State regulatory body
oversight for that same issue.
Senator Bingaman. You do not think FERC should have
additional authority to oversee and intervene in case of
mergers and acquisitions?
Mr. Sokol. Our company's policy is we do not have a problem
with FERC having that. We would be willing to support that.
Having reviewed what the other Federal agencies have already as
a right, it would seem duplicative. But from our perspective,
it does not matter.
Senator Bingaman. Okay. I will stop with that, Mr.
Chairman. Thank you.
Senator Thomas. Senator Johnson, any more questions?
Senator Alexander.
Let me just finish with one here, Ms. Smith. We do not want
to let you get away too easy here. The credit rating for many
energy companies has been reduced, some below the investment
grade. Agencies have been accused of reactionary downgrading
and changing valuation criteria. How do you react to that?
Ms. Smith. Well, I think there are various reasons why the
credit decline has occurred. And, you know, they really have
very little or nothing to do with the actions of Standard and
Poor's directly or any credit rating company. The presence of
ratings triggers, in particular, has been a problem and caused
acceleration in credit downgrades, because the companies are
particularly vulnerable, operating at a low investment grade
ratings triggers.
Because of liquidity, really severe liquidity, issues, we
have taken a look at, you know, at the ratings very carefully.
Liquidity has become a very important component of ratings. It
always has been. But I guess our emphasis has changed a little
bit.
But we have not changed in any fundamental way our criteria
for evaluating companies. Criteria is always evolving. But it
has not really caused any slide in creditworthiness as it
applies to a particular industry or the electricity industry.
So I think that the comments that we have been reactionary
are misplaced, in that we are responding to really a serious
decline in industry fundamentals and financing practices that
have really caused the decline, more than any action that
rating companies have taken.
Senator Thomas. Thank you.
I am ready to close, Senator, if you have nothing more.
Thank you all for being here. And I hope you will stay with
us during the policy efforts and have some input as to how we
can work on making these problems work out a little better. I
think that is our challenge.
Thank you all for being here.
[Whereupon, at 11:25 a.m., the hearing was adjourned.]
APPENDIXES
----------
Appendix I
Responses to Additional Questions
----------
MidAmerican Energy Holdings Co.,
Omaha, NE, March 18, 2003.
Hon. Pete Domenici,
Chairman, Senate Energy and Natural Resources Committee, Dirksen Senate
Office Building, Washington, DC.
Dear Senator Domenici: In response to your March 5 letter to me,
enclosed are my answers to the list of questions that have been
submitted for the record in connection with my March 4 testimony before
the Senate Energy and Natural Resources Committee regarding financial
conditions in the electricity markets.
Please do not hesitate to contact me if you or other members have
any additional questions. Once again, I appreciate your giving me the
opportunity to discuss my views on these important issues.
Sincerely,
David L. Sokol,
Chairman and CEO.
Questions Submitted by Senator Domenici
Question 1. I would like each of you to explain what you think the
primary factors are that have led to the current financial situation in
the electricity sector.
Answer. I believe there are four primary factors, in addition to
the recessionary economy we are facing:
a. Congress introduced wholesale competition into this sector with
passage of the Energy Policy Act of 1992. This competition increased
the risk profile and complexity of the industry, thus diminishing the
sector's historic position as a safe haven for small investors.
However, Congress did not eliminate PUHCA at that time, so it provided
no mechanism for large investors who are able to ride out volatility to
enter the marketplace or to invest in the market. As a result,
individual ownership of utility equity has declined rapidly, often
replaced by debt.
b. The failure of Congress, FERC and the states to reach agreement
to harmonize the regulatory environment has created a level of
uncertainty that has discouraged investment and driven up the cost of
debt. Investors won't invest in regulated assets unless they are clear
as to how those investments will be recovered. Investors will also
hesitate to invest in competitive generation assets if it appears that
Congress will turn away from wholesale competition.
c. Many companies made honest investment mistakes, failing to
appreciate the cumulative impact of numerous companies pursuing overly
aggressive growth strategies at the same time. That resulted in a glut
of generation, and since almost all the new generation is gas-fired,
the situation may get worse. In addition, a number of companies
overpaid for international assets and trading platforms.
d. It is difficult to overstate the negative impact on the industry
of the Enron collapse and the revelation of other examples of severe
corporate misconduct. These types of situations are by no means unique
to our industry, but the fact that Enron was the first and the most
high profile company to collapse under its own accounting fictions and
excesses has resulted in a disproportionate impact on the electricity
and gas industries.
Question 2. To what extent do you think the challenges facing the
electric industry are related to the general downturn in the economy?
Answer. Electricity demand is closely tied to GDP growth, trailing
GDP growth by about 1% (except for peak demand). Although residential
electricity demand has remained relatively consistent over the past few
years, there has been an actual decline in electricity use in the
industrial sector. The general downturn in the economy has thus
undoubtedly contributed to the set of problems caused by the excess
supply of generation in some regions, but our weak economy is actually
masking the longer term structural problems our industry faces.
Infrastructure growth continues to lag far behind load and
transactional growth. I share Senator Bingaman's concern that in a few
years we may see the conditions that contributed to the Western energy
crisis recur.
Question 3. Can you give us some perspective on other industry
sectors and whether they are facing challenges similar to those
confronting the electricity sector?
Answer. As competition has been introduced into the electricity
sector, it has begun to confront the same market risks common to other
capital-intensive industries. Like steel, chemicals, paper, and oil and
gas, the electricity sector must manage business cycles, supply costs
and risks, technological changes, and susceptibility to boom and bust.
The decline in the industry's credit outlook has resulted in part
from the beginning of deregulation. Electricity's traditional monopoly
status, with a captive base of customers, provided the industry with
strong credit quality and easy access to capital markets. The advent of
competition has shifted risks to lenders and away from ratepayers. That
certainly comes as no surprise, as regulation has always supported
credit strength.
Competitive industries, of course, need customers, and that is
where the partial deregulation of the electric industry has resulted in
challenges that are different from other industries. Regulatory reform
in our industry has proceeded more slowly and more narrowly than in
other industries. As a result, the factors that support competitive
markets still do not broadly exist, as our industry continues to have
``one foot in the boat, one foot on the dock.'' This, in turn, has
resulted in redistribution of risks and market distortions that
continue to plague our industry. For example, competition generally
ends at the wholesale level instead of reaching the retail level. In
addition, retail rates in some markets are mandated to drop, thus
benefiting consumers while dramatically shifting investment costs from
ratepayers to investors and lenders.
Question 4. The credit rating for many energy companies has been
reduced, some to below investment grade. The credit rating agencies
have been accused of reactionary downgrading and changing valuation
criteria. How do you respond to those allegations?
Answer. There may be some degree of overreaction, but overall I
believe the agencies are responding responsibly to market realities.
Blaming the rating agencies for the industry's problems is more blaming
the messenger than acknowledging that many companies made mistakes.
Question 5. Do you thing that developers overestimated the demand?
Answer. Generation developers clearly overestimated demand, and I
agree with Mr. Silverstein that the financial community became
undisciplined in many cases. In such a high capital industry, it will
take years to unwind some of these mistakes.
Question 6. Are the problems now faced by competitive generators
due to overbuilding?
Answer. Overbuilding and the lack of regulatory certainty are the
two main problems facing competitive generation. We clearly have
overcapacity in some regions of the country, and the fact that we
haven't settled the regulatory groundwork or made any inroads in
increasing transmission infrastructure makes matters worse. Some
investors might be willing to acquire significant stakes in generation
if the roadmap to large regional transparent markets were more clear.
With transmission constraints and regulatory uncertainty, investors
can't count on even the long-term value of these assets.
Question 7. Is there an over abundance of generation supply? Is it
concentrated in certain regions of the country? How long will it last?
Answer. In the late 1990s, there were regions of the country that
needed or were close to needing new capacity to meet consumer demand.
In response to the demand, approximately 150,000 MW has been
constructed since 1997, and another 55,000 MW is scheduled to come
online this year.
The generation supply situation today is not uniform throughout the
country. California and southern Nevada, New York, southern New
England, and parts of the upper Midwest will be the first regions to
face renewed supply constraints, while Texas and the mid-Atlantic have
the most excess supply. Nationwide, it is estimated that the average
U.S. reserve margin will peak at 34% in 2004. How long the
overabundance lasts will depend in part on the economy. Our best
estimate is that it will be five to ten years before prices will come
to the level that would justify building new plants. Plants today are
selling at $50-$200/kw, while the cost of construction is about $600/
kw. It will take at least five years before forward margins would
generate a return on investment that would warrant a $600/kw
investment.
Question 8. What is your response to this potential issue of
insufficient natural gas supplies and increased dependence on LNG?
Answer. The adequacy of natural gas supply and infrastructure is
one of the most critical long-term policy issues facing the country. Of
the new 144 gigawatts added between 1999 and 2002, 138 were natural
gas-fired facilities. The percentage of generation from natural gas is
projected to increase from 17 percent in 2001 to 29 percent in 2025,
including generation by electric utilities, independent power
producers, and combined heat and power generators. While I understand
the attraction of using natural gas for generation because it is clean
and efficient, I am concerned that this trend may lead us into a supply
crisis for natural gas and require increased dependency on foreign
imports of LNG.
This winter, for the second time in the last three years, natural
gas prices have soared, straining family budgets, disrupting
manufacturing activities, and placing further pressure on agriculture.
The fact that the system can't absorb a moderately cold winter during a
slow economy demonstrates how fragile the situation is. Congress needs
to adopt a multi-pronged approach to this situation. First, we must
obtain more supply. Even at current prices, we are depleting supply
sources faster than we are drilling new wells. Some of the most
promising areas for new development have been placed off-limits by
federal policy, and exploration in other areas is severely restricted.
The United States should not have to import our way out of this
problem, given North America's domestic reserves. And LNG can only be a
partial answer.
The second element of problem is on the demand side. The
environmental policies of the previous Administration resulted in
almost no new coal generation, and we still do not have the regulatory
certainty for investors to move forward with new nuclear projects. We
need to identify responsible approaches to maintaining coal and nuclear
generation (which together account for almost 80% of U.S. generation),
in order to ease demand pressure on gas.
Third, we also must make more use of renewables and CHP (combined
heat and power) through long-term extensions of the production tax
credits that help offset the high capital cost of renewable
development. I believe we can increase the percentage of renewables in
the generation mix to 6-8% by 2020 without mandates or negative impacts
on consumers.
Question. Between January 2000 and July 2002, more than 90,000 MW
of capacity were delayed and more than 86,000 MW of capacity were
cancelled. The costs associated with these delays and cancellations are
significant. For example, there are reports that merchant generators
must refinance $90 billion of debt over the next four years, with $30
to $50 billion coming due in the next two years alone.
9. Do you think that these companies will successfully refinance
their substantial debt? Or should we prepare ourselves to see a series
of generating assets fall into the hands of banks?
Answer. A number of companies that were overly aggressive in
generation expansion face either bankruptcy or complete restructuring.
The number ranges from 6 to 12 depending on the overall health of the
economy and natural gas prices. A substantial amount of generation will
be put up for bid and some assets will undoubtedly end up in the hands
of financial institutions. While I believe that some huge mistakes were
made by companies that followed the merchant generation model,
Congress, FERC and the states should work to harmonize policies on
market structure and transmission development so that the majority of
this investment can ultimately be put to beneficial economic use.
Question 10. Given these financial constraints, will the merchant
generator model survive?
Answer. The pure merchant generation model may not survive, but
that should not mean that competitive generation doesn't survive. If--
and hopefully when--PUHCA is repealed, it will be possible to build
electric companies with geographically diverse asset mixes that include
both competitive generation and regulated distribution and can be owned
by any willing investor.
Question. Energy security requires a reliable, efficient
transmission system. Some reports claim that annual investment in
transmission has declined by almost $120 million a year for the past 25
years. The North American Reliability Council found that transmission
investment over the next 10 years will grow by little more than 10,000
miles. The transmission system consists of 158,000 miles, so that is
about a 5% increase.
11. What are the reasons for this lack of investment in
transmission infrastructure?
Answer. See answer to question 14, below.
Question 12. What potential solutions should be considered to
improve this situation?
See answer to question 14, below.
Question. Over the past decade, transmission service policy has
required increased open access to promote competition in generation
supply. Generation supply has expanded, sometimes exceeding consumer
needs; transmission expansion has lagged.
Are there immediate consequences for this failure to expand
transmission?
Answer. See answer to question 14, below.
Question 14. What do we need to do to ensure adequate transmission
for the future?
Answer. There are three major problems with getting new
transmission built: (a) regulatory certainty in terms of cost recovery;
(b) procedural barriers to siting new transmission; and (c) PUHCA's
limitations on investment.
Large multi-state projects that provide dispersed regional benefits
will not get built until the regulatory environment is more clear. The
procedural and environmental barriers to building new transmission can
also be enormous, with some needed projects languishing for decades.
This is particularly true of renewable projects, which are location-
specific and therefore cannot be flexibly located. The environmental
community simply must become more responsible, given the massive
benefits in terms of clean air and avoided emissions that a robust and
efficient transmission grid will provide.
Finally, PUHCA is making the financing and governance of
independent transmission companies extremely challenging. The ownership
of transcos must be heavily dispersed to prevent investors from
triggering PUHCA's limitations. It is difficult enough to assemble the
capital and management structure to establish one of these entities
without PUHCA. It's that much harder to do so 4.99% at a time, which is
the limitation imposed by PUHCA.
Based on our conversations with the financial community, MEHC and a
number of other electric companies have developed an agenda for
addressing the capital crisis that includes four legislative
recommendations on transmission:
a. Enact some form of the transmission spin-off language so that
utilities can meet their Order 888 requirements.
b. Decrease the depreciable life of transmission assets to a more
reasonable level.
c. Streamline transmission siting by coordinating federal agency
actions and establishing cooperative regional organizations that are
ideally supported with federal authority; and
d. Replace or eliminate PUHCA.
Finally, Congress should work to encourage harmonization of the
federal-state relationship in order to smooth the transition to open
competitive wholesale markets.
Question. FERC recently proposed incentive transmission rates for
entities that transfer their transmission assets to RTOs (Regional
Transmission Organizations) or Independent Transmission Providers.
15. Do you think that this is an effective inducement on companies
to transfer transmission assets to RTOs?
Answer. This is one of a number of incentives that would serve as
effective inducements. Others would be to repeal PUHCA and to harmonize
state and federal regulations.
Question. Many claim that difficulties in transmitting siting and
permitting procedures are a major reason why transmission development
has not kept pace with need.
16. What are viable solutions to this challenge?
Answer. From a strictly operational standpoint, I would recommend
the natural gas pipeline model. This has worked well to facilitate new
infrastructure development. At the same time, I recognize the intense
political passions that arise from any discussion of federal siting
authority, particularly in the West. Regional approaches are needed,
but I understand these are constitutionally difficult to implement. An
evolutionary approach that relies on joint federal-state boards (or
interstate compacts) and leaves specific siting decisions in the hands
of the states may be the best Congress can do. Congress must, however,
do something.
Question. The electric industry has been evolving toward a more
competitive model, specifically in wholesale power market. Given where
we are today, some seriously question whether this is the model that
will best serve consumers and our national interest.
17. Do you think that increased competition in the electricity
market promotes reliability, economic pricing and environmentally safe
power?
Answer. Given sound market rules that conform with fundamental
economic principles and the technical realities of the industry,
wholesale electric competition should produce lower prices relative to
regulation, more innovation, and higher levels of reliability. As has
been noted elsewhere, the DOE's most recent estimates are that
wholesale competition saves consumers $13 billion annually. Well
structured markets in the mid-Atlantic and Texas are providing
substantial consumer savings, even with rising fuel costs. Our economy
simply cannot afford to throw away these benefits. In the post 9/11
world, one of the greatest challenges our industry faces is not only
increasing system redundancy to insure reliability, but also increasing
overall reliability by several orders of magnitude. If we are to do
this, and do it affordably, we cannot simply rely on old-style
regulation that provides little incentive for innovation.
Question 18. Competition in electricity brings volatility in
prices, but does it also bring lower prices for consumers?
Answer. There are two main ways to reduce volatility: First, build
a robust transmission grid supported by clear market rules, so that
willing buyers and sellers can be brought together over the widest
possible area. Second, establish regional capacity markets that spread
out the cost of meeting demand peaks more evenly. Critics of the SMD's
requirement that RTOs establish some form of regional capacity markets
are off-base. This is not an intrusion on state authority, but the best
way to insulate states in a region against the failure of another state
to meet its supply obligations.
Question. While much of my focus has been on expanding the physical
power infrastructure, I would also like your input on the following.
19. What are other effective ways to improve our energy
infrastructure that do not include the expansion of generation or
transmission facilities?
New emerging technologies such as fuel cells, distributed
generation, CHP, high conductivity transmission, and metering systems
that support demand-side solutions all should play a role in meeting
the country's energy and environmental challenges. Last year's energy
bill included broadly supported bi-partisan approaches on these issues.
This is one more reason why Congress must leave behind adversarial
gridlock and pass an energy bill.
Question 20. What kinds of incentives are needed to encourage
energy companies to invest in advanced technology for both generation
and transmission?
Taking the legislative and regulatory steps to create vibrant
competitive wholesale generating markets should provide the major
incentive for generators to invest in new technology. For renewables,
extending the Section 45 production tax credit and expanding it to
cover all renewables will help offset high capital costs. On
transmission and generation, regulatory certainty of cost recovery for
advanced technology investments and ratemaking structures that reward
these investments are the most important components.
Questions Submitted By Senator Bunning
Question 21. While there is currently an abundance of electricity
generation, if demand continues to increase steadily and building of
new electricity generation continues to remain stagnant, we are
expected to face under-capacity of electricity in the very near future.
Besides repealing PUHCA (Public Utility Holdings Company Act), what
else do your propose would spur investment in new generation to meet
future demands?
Answer. For the most part, market forces should govern the
generation market. However, we also need to recognize that electric
generation is part of an integrated network system. It is a high
capital, large footprint, long-lead time in development industry that
has to deal with fairly unique environmental challenges.
Because of these characteristics, there are a number of policy
challenges that generation faces:
a. As emissions limitations become increasingly stringent, Congress
should look to provide incentives to the industry to keep available
capacity on-line while meeting these new environmental requirements.
Depreciation schedules for pollution control equipment installed on
power plants built after 1975 are 20 years, as opposed to 5 years for
pre-1975 plants. Congress should consider reducing the post-1975 class
depreciation schedules to facilitate emissions reductions that will
have broad social benefits.
b. Any legislation that improves transmission siting will provide a
large, indirect benefit to generation, particularly renewable
resources. One of the greatest challenges we face with our geothermal
operations in California is the need for a more robust transmission
system to bring power generated in a remote location to load centers.
The same problem can hold true for conventional projects such as mine
mouth coal.
c. Although MidAmerican owns only a minority share in two nuclear
units, I also would strongly encourage Congress to finally finish the
job of reauthorizing the Price-Anderson Act.
d. Utilities are also facing increasing demands at the state level
to increase their share of renewable generation. Extending and
expanding the Section 45 tax credits to all renewables will help bring
these resources to market at affordable rates for consumers.
e. On the regulatory side, the more certainty we have in areas such
as contract sanctity, the more likely the financial community is to
return to the industry.
f. Finally, FERC's ongoing regulatory efforts should ensure that
adequate price signals are sent to develop regional capacity markets.
This will have the advantage of reducing price volatility and diminish
the tendency of the industry to go through boom and bust cycles.
Question 22. On January 15, 2003, FERC issued a Proposed Policy on
Transmission Rate Incentives to force structural change in the
electricity market. FERC investigations have shown that utilities have
turned away transmission customers--even though space was available on
utility lines--in order to eliminate competition for power sales by
their own affiliated generators. This practice in effect deprived
consumers of access to lower cost power. FERC has said its proposed
order will reduce the sway held by utilities over the grid, and thereby
help consumers. Do you believe that the proposed order will help
consumers have lower rates?
Answer. I believe the overwhelming majority of utilities operate
their transmission systems consistent with FERC Order 888 and the
principles of wholesale open access. The problem has been that it is
difficult to ensure that this is being done due to the real-time nature
of electricity markets. In a competitive market, the financial stakes
of these issues can be huge, thus casting a cloud over operational
decisions.
The best working competitive markets, both in the United States
(ERCOT, PJM) and abroad, have fully separated operational control of
the transmission system from generation to ensure that there is not
even a question of preferential access. That increases confidence in a
truly competitive wholesale market and will encourage the financial
community to give a second look to merchant generation.
We are not aware of a specific case in which FERC has actually
found that a utility has turned away a transmission customer when space
was available on its lines in order to eliminate competition, although
there still remains a conflict between the requirement for open access
and the state requirement to give preference to serving native load in
order to meet the traditional obligation to serve.
Question 23. Many energy companies are currently facing severe
financial difficulties. Some of these companies hurt by bad investments
are attempting to pass their financial burden onto stable utilities
that have survived the energy crash. Because of this, many utility
customers are paying millions more for their utility bills due to the
energy companies improperly pushing utility affiliates to pay for their
expenses. As many of you know, I am not a proponent of unnecessary
regulation. But how else do you propose we fix this problem so that we
can protect our consumers?
Answer. Both state regulators and FERC have full authority to
review all rate-based costs under their jurisdiction and deny recovery
of any costs that are not prudently incurred. Additionally, state and
federal regulators have extensive authority to prohibit cross
subsidization to prevent any attempts by companies to encumber utility
assets with debt that supports competitive ventures.
FERC's recent draft order under its Section 204 authority
concerning utility financings of non-utility ventures is an important
step in the right direction.
Most state commissions have done an excellent job protecting
utility ratepayers from negative impacts of competitive investments by
utility parents. Regulators have extensive tools to do this, though in
some cases events of the last two years may provide the impetus to use
these tools more aggressively.
Question 24. Standard Market Design (SMD) has been proposed by FERC
to fix instability in the marketplace. Kentucky has the lowest
residential electricity rates in the country. Do you believe that
FERC's proposed SMD rule will work? Will the rule penalize states with
low costs to benefit those with high costs? Do you believe that the
proposed SMD rule takes into account unique regional differences and
individual state interests?
Answer. The Standard Market Design (SMD) proposed by FERC provides
an appropriate outline for wholesale electricity markets. At the same
time, I have encouraged FERC Chairman Wood to take more time to explain
the SMD to Congress, the states and industry stakeholders, and to show
as much sensitivity to regional concerns as possible.
I don't see any reason why SMD should harm Kentucky's consumers or
consumers in the state of Iowa, where the majority of MidAmerican's
utility operations are located. Like Kentucky, Iowa is a relatively
low-cost state in the middle of the country that maintains traditional
regulated retail electricity service. A robust wholesale electricity
market with clear market rules and no barriers to investment benefits
our company and our consumers each time we either have extra power that
we can sell on the market (profits are split between the company and
ratepayers) and each time we can buy power on the market at a favorable
price.
Though there are many challenging transitional issues to consider,
it's important to remember that transmission is by far the smallest
component of a monthly utility bill. Generation costs are more than
three times the cost of transmission service in the average utility
bill, and that's where the real savings for consumers lie.
Questions Submitted By Senator Campbell
Question 25. As this Committee moves forward on developing a
comprehensive energy bill and as FERC evaluates its proposed ``Standard
Market Design'' rule, the effect on consumers must be given the highest
consideration.
Answer. I strongly agree that the impacts on consumers of SMD or
any other legislative or regulatory change should be both Congress' and
FERC's primary concern.
Question. Delivering electricity across wide expanses is costly,
and changes in topography increase those costs dramatically. My state
of Colorado, which lies on the edge of the Western interconnection
probably has the most difficult topography in the lower 48 states. Yet,
Colorado ranks in the top quarter of least expensive states for
electricity prices in the nation. Denver's electricity prices rank as
one of the nation's five least expensive.
26. Why should we seek to change a policy that has worked well for
states like Colorado?
Answer. Colorado benefits from having abundant natural resources,
including plentiful supplies of coal and natural gas relatively near
the state's population centers. More than any other reason, this is why
Colorado and Denver electricity prices are low. At the same time, they
could be lower. The Front Range of Colorado is constrained by
inadequate transmission capacity to the north, west and south. In
addition, the state's largest utility is electrically surrounded by a
federal power-marketing agency, the Western Area Power Administration.
This results in inefficient and discriminatory use of the existing
transmission grid by prohibiting the flow of low cost power outside of
Colorado to the Front Range. FERC's SMD proposal would take baby steps
to remedy such inefficiencies by making transmission services
reciprocal and comparable to all users of the grid, on a non-
discriminatory basis. True reciprocity and comparability require
enabling legislative action.
It is important to note that there is a significant amount of
misunderstanding as to what FERC's SMD does for states that maintain
traditional regulated retail service. Nothing in the SMD would make any
state change its regulatory scheme from regulated service to retail
competition. The details of the SMD should continue to be improved
through the ongoing regulatory process, but I agree with the financial
analysts who testified at the Committee's hearing, as well as those who
testified at the FERC technical conference in January, that regional
differences should be manageable within the SMD framework.
Question 27. How can we be sure that any policy change would not
detrimentally impact ratepayers?
Answer. FERC's SMD proposal contains provisions that assure
customers can continue receiving the same types of services at prices
they are used to, if they so choose. Customers have an option to enter
into long-term contracts that would preserve existing prices and terms
of service. In addition, existing contracts would be ``grand fathered''
or preserved for the remainder of the contract term.
Nevertheless, there is no way to guarantee that prices in a
competitive energy market will be lower in the future than they are
today. There are too many variables, as the recent spike in natural gas
prices demonstrates, to make an iron clad guarantee of that sort.
However, if SMD accomplishes its goal and makes it easier, more certain
and less expensive to move power around the grid, the overwhelming
majority of consumers, even those in low-cost states, should benefit.
While some may view the scope of the SMD proposal as broad, the
fact remains that transmission plays a fundamental role in achieving
savings in this sector. As the MIT economists Paul Joskow and Richard
Schmalanzee pointed out 20 years ago in their book, Markets for Power:
``The practice of ignoring the critical functions played by the
transmission system in any discussion of deregulation almost certainly
leads to incorrect conclusions about the optimal structure of an
electric power supply system.''
Failure to address competitive issues in the transmission system
will result in continued high risks for this industry, with concomitant
low credit ratings, higher costs of capital, and higher rates for
consumers.
Question. Central to SMD is the idea that transmission assets will
be placed in the hands of Independent Transmission Providers (ITPs).
These ITPs will not have any ownership interest in the assets, but
rather will be expected to operate them in the ``public interest.'' Can
you give me examples of when such a system has worked well in the past.
28. There seems to be general agreement that needed investments in
our transmission infrastructure are not now being made. But, I can't
find anything in the SMD proposal that improves the incentives of the
private sector to make these investments. The proposal seems to
envision a rather cumbersome planning process involving the ITPs and
other regulatory entities. Navigating this regulatory labyrinth would
seem, by itself, to be a disincentive to investment. In your view, does
the SMD improve the incentives for transmission investment and, if so,
how does it do it?
Answer. The not-for-profit ITP is one of two options that the SMD
provides for operation of transmission assets. The other option, and
the one MidAmerican prefers, is the independent transmission company,
or ITC, that is a for-profit business. The independent transmission
organization MidAmerican will participate in, TRANSLink, includes not
only investor-owned utilities (such as Colorado's largest utility, Xcel
Energy), but major public power and rural cooperative systems as well.
The not-for-profit model works well in both the PJM system and
ERCOT, but the model that is evolving with or without the SMD is to
have for-profit transmission companies operating within an umbrella
regional transmission system.
As far as the concern that the SMD is a ``regulatory labyrinth,''
obviously the proposal is complex, and I hope when FERC gets around to
issuing a final ruling it can find a way to shave a few hundred pages.
Any concern about the complexity of the SMD is significantly outweighed
by the benefits of finally clarifying transmission jurisdiction so that
we know who will have regulatory authority to ensure that investments
in necessary transmission expansions and upgrades are made. Unless
investors know how they will recover the costs of investments in
interstate transmission, they simply will not invest.
The system desperately needs harmonization between state and
federal regulatory authorities. Deputy Secretary McSlarrow put it very
well in his recent statement before the House Energy and Commerce
Committee, noting that on transmission we have three choices: 1) turn
back the clock, which is impossible; 2) remain stuck in transition,
which is untenable; or 3) complete the transition to competitive,
regional energy markets for the benefit of consumers.
With respect to incentives, FERC's SMD proposal, in and of itself,
does not provide sufficient incentives for transmission and generation
investment. The proposal acknowledges the important role independent
transmission companies can play as a result of their single-minded
focus on a transmission-only business, and it provides for greater
pricing transparency than now exists by requiring locational marginal
pricing for congestion management, thus signaling to investors where to
locate sorely needed infrastructure.
Legislative action is required to truly spur investment in badly
needed infrastructure. This would include repeal of PUCHA,
clarification of FERCs authority over all transmission rates and terms
of service, and modification of tax policies that penalize compliance
with Order 888 and 2000 requirements. Interstate electric transmission
should not be treated differently than interstate natural gas
pipelines, both in terms of the allowed rate of return on equity and
depreciation schedules, but it is. In fact, electric transmission
infrastructure may be a more risky investment than a natural gas
pipeline when taking into account construction, permitting, siting and
capital risks.
Question 29. Some of you are in the wholesale power business where
the SMD proposal would impose price caps. Won't those price caps
distort investment incentives in this market?
Answer. I am philosophically in favor of free markets, and I view
anything like price caps as an absolute last resort when markets are
clearly dysfunctional. The price caps envisioned in the SMD are
reasonable as ``circuit breakers'' to keep markets from spinning out of
control. I would expect if regional capacity markets are established as
envisioned in the proposal, the price caps would rarely, if ever, be
applied.
Question 30. The SMD proposal doesn't apply to public power, which
is outside of FERC's jurisdiction. Since large areas would not be
covered, how can SMD lead to a ``standard'' market design?
Answer. A robust SMD would bring all owners of significant
interstate transmission assets under some form of FERC jurisdiction.
Under existing law, FERC does not have that authority, so it would take
Congressional action to give it that authority.
I understand that Senator Thomas' electricity proposal would
include the ``FERC lite'' compromise that was negotiated in the house
almost four years ago. I support that, as do virtually all private
sector energy companies, both utilities and independents. There are
also public power systems that are voluntarily joining regional
transmission organizations (RTOs), such as the two large Nebraska
systems that are our partners in TRANSLink.
Question 31. The SMD proposal is advertised as promoting
competition, but isn't it really just a new regulatory regime.
Moreover, given the complexity of the market that FERC is attempting to
``design'' isn't it inevitable that there will be serious errors--
errors that will be difficult to correct in a regulatory context?
Answer. It's accurate to note that the SMD is a new regulatory
regime, but it is primarily a restructuring of the regulated
transmission grid to facilitate competition in generation.
Transmission, by definition, is a monopoly function, and it will always
be regulated. Those who are trying to claim that in transmission there
is some philosophical issue between regulation and competition are
simply being disingenuous.
On the issue of whether there will be errors made in developing the
SMD, or even if we didn't move forward with the SMD but simply
implemented Order 888 requiring all utilities to join regional
transmission organizations, the answer is yes. Mistakes will certainly
be made, and we will have to learn from them. It is important to
remember, however, that California's market design that wreaked so much
damage on the state and the west, wasn't the result of the SMD or even
Order 888.
The issue of mistakes is exactly why I believe Congress should not
try to legislate a market design. I'd much rather try to fix mistakes
made through regulation than those that are written into public law.
Questions Submitted By Senator Cantwell
Question 32. One of the reasons the Public Utility Holding Company
Act (PUHCA) was established was because of cozy relations between
utilities and their affiliate companies. I have read that Berkshire
Hathaway holds an interest in Fitch rating service, that Fitch has been
more aggressive than the other rating agencies in down-grading various
utilities, and that MidAmerican has bought assets--at attractive
prices--from down-graded utilities. I am not accusing your company of
unduly influencing the prices of the assets you purchased, but the
appearance is not favorable. Wouldn't stand-alone PUHCA repeal lead to
more transactions with similarly questionable appearances, and won't
this shake investor confidence in the market?
Answer. Berkshire Hathaway owns no interest in the Fitch rating
service. It does, however, own an approximate 15% interest in Moody's.
Berkshire Hathaway has absolutely no influence on Moody's ratings
determinations. In light of the fact that the rating agencies derive
their fees from debt issuers, a rating company that were to engage in
the conduct you suggest would soon lose its client base and be out of
business. No such allegations have ever been made, and this type of
innuendo should have no place in this record. These charges are
unfounded, inappropriate and unwarranted in light of Berkshire
Hathaway's long record in support of shareholder rights, increased
corporate disclosure, expensing options, and other corporate and
accounting reforms that have made it a model for corporate governance
transparency.
Question 33. You talked today about the impediments on your company
making additional investments. I agree that we want to further
investments in generation and transmission, but my understanding is
that an exemption already exists for generation investments. So its
investments in new transmission that might be restricted by PUHCA.
[Sic.] Why don't we look at a narrow PUHCA amendment addressing the
transmission issue, rather than repealing the entire statute and its
other important protections?
This question raises an important point. PUHCA is, as any
reasonable person would agree, an impediment to investment in the
industry at a time when it is desperately needed. If you break down the
industry into its basic components, you can understand why PUHCA repeal
will benefit consumers and that concerns about its repeal are
misplaced.
Generation is partially free from PUHCA investment restrictions,
but registered companies are limited in the amount of exempt generation
they can own, while PUHCA-exempt utility and independent generators are
not. That is a clear competitive distortion. PUHCA's geographic
integration requirement prevents geographic diversification of assets,
and that is counterproductive to all antitrust principles of the past
century.
As to transmission and distribution, a transmission company
exemption would address stand-alone transcos, but PUHCA would continue
to restrict ownership of transmission assets that are still owned by a
utility but placed under the operation of an RTO. Another example
pertains to our interest in expanding our Imperial Valley geothermal
operations. These plants currently provide the California electricity
market with approximately 340 megawatts of baseload, emissions-free,
renewable electricity. We are planning to double the size and output of
these facilities, providing more renewable electricity to the
California market. This project will require the construction of
additional transmission lines, which we considered undertaking, but
PUHCA's restrictions stood in the way.
Rather than hearing from MidAmerican on this issue, it might be
better to consider the arguments of the Oregon Public Utilities
Commission (OPUC) to the SEC on the issue of whether Enron's single-
state utility exemption for Portland General Electric (PGE) should be
revoked. OPUC, presumably acting to protect Oregon's ratepayers and to
seek lower rates, made three key points in its opening and reply
briefs: First, the state of Oregon, through the OPUC, has adequate
regulatory authority to protect the regulated utility customers of the
state without PUHCA:
The OPUC has adequate authority to regulate [PGE's] utility
activities regardless of whether [PGE] trades at the Oregon
border or elsewhere. . . . The OPUC effectively regulates these
[PGE] activities through the regulatory scheme provided for in
Oregon. Although [PGE] enters into some wholesale transactions
outside of Oregon, the OPUC has access to the books and records
of these transactions. Opening brief, p. 3.
Second, applying the provisions of the administrative law judge's
proposed ruling revoking the exemption would effectively punish Oregon
consumers by causing PGE to limit its wholesale sales to avoid PUHCA
registration, thus discouraging PGE from: (a) using supply management
tools that reduce costs to consumers and (b) making off-system sales
that result in shared savings for PGE and its consumers. ``It benefits
Oregon ratepayers that Portland General transacts purchases and sales
of electricity at wholesale in the most cost effective markets
available in the Western Interconnection, regardless of where such
markets happen to be located.'' Opening brief, p. 3.
Third, forcing a utility to sell excess power in-state in order to
maintain a PUHCA intrastate exemption ``has the potential to result in
adverse utility behavior.'' As OPUC explained: ``Nearly all utilities
sell excess power, which often ends up out of the state. Adoption of [a
strict ``bright line'' test of out-of-state sales] could result in
utilities deciding to sell excess power within the state, often at
lower prices.'' Reply brief, p. 3. This test could also hinder the
ability of utilities needing excess power to purchase that power at the
most effective location. As OPUC explains, when Portland General has
the opportunity to purchase cheap hydro power, it can sell excess
thermal power in the wholesale market and benefit its customers:
If the [SEC], however, creates a disincentive for [PGE] to
sell excess power out of state by subjecting it to [PUHCA],
[PGE] may decide not to purchase the less expensive
hydroelectric power and, instead, serve its native Oregon load
with its higher cost thermal resources. [PUHCA] should not
create an incentive for [PGE], or other utilities, to pursue
behavior adverse to its retail customer, especially in this
situation where the OPUC adequately and effectively protects
all of [PGE's] retail customers. Reply brief, p. 3.
The simple, well understood answer to this investment problem is to
replace PUHCA and its counterproductive unintended side effects with
enhanced books and records access so that state and federal regulators
have complete access to all utility holding companies. That's the basis
of effective regulation: holding utilities accountable ``by the rate
base.''
Questions Submitted By Senator Feinstein
Question. You have all testified about the poor financial condition
of energy companies and the challenges they face in the financial
markets. I believe companies have seen their credit ratings downgraded
and their stock prices plummet because there is a crisis of confidence
among consumers and investors.
34. Do you agree that prudent government oversight to prevent
against fraudulent and manipulative behavior and more transparency in
the marketplace will help improve the financial condition in the energy
sector?
Answer. As I have stated on several occasions, CFTC oversight of
energy trading and futures markets is appropriate. Some believe the
CFTC already has authority in this area, but current law is unclear at
best.
Question 35. Currently the energy trading sector is devoid of
transparency and adequate oversight. I plan to re-introduce legislation
with Senators Fitzgerald, Lugar, Harkin, Cantwell, Wyden, and Leahy to
bring oversight to unregulated energy trading and increase penalties
for misconduct. Do you support the goals of this legislation?
Answer. I believe it is appropriate and desirable to clarify which
federal agency has authority over energy trading.
Question 36. If you have had the opportunity to review the specific
text of the bill, do you wish to go on record as a supporter?
Answer. MEHC is reviewing the text of the bill you have introduced.
We support the intent of the bill and will provide comments in the near
future.
Appendix II
Additional Material Submitted for the Record
----------
Statement of the Edison Electric Institute
Mr. Chairman, Members of the Committee, the Edison Electric
Institute is pleased to submit this statement for the record of the
Committee's hearing on ``Financial Conditions of the Energy Market.''
EEI is the association of U.S. shareholder-owned electric utilities and
affiliates and associates worldwide.
In this statement, we will first provide an overview of the current
financial situation in the electric utility industry. We will then
briefly describe what Congress can do to help address many of the
financial challenges facing the industry today.
the electric utility industry is responding to unprecedented
financial challenges
The past year has brought some of the most significant financial
challenges ever experienced by the electricity industry. Shareholder-
owned utilities are feeling the sharp impact of an economic slowdown
and the aftershocks from the implosion of Enron, and they are
aggressively taking steps to promote greater transparency in electric
power markets to rebuild investor confidence.
They are selling non-core assets, downsizing, issuing new equity,
canceling acquisitions, reducing significant levels of capital
expenditures, realigning trading around their own generation assets and
customer obligations, and accelerating debt repayment. Many are
adopting a ``back-to-basics'' strategy with its primary focus on their
core regulated business.
In addition to individual company actions, EEI, along with Chief
Risk Officers of utilities, is leading industry efforts to develop best
practice models in disclosure, risk management, and market oversight.
Working with Deloitte & Touche, EEI developed a comprehensive study of
``best practices'' financial information disclosure guidelines that are
responsive to the Sarbanes-Oxley Act. EEI also has developed guidelines
for a Model Audit Committee Charter, and a Master Netting Agreement
designed to enable companies to better manage their risks and improve
liquidity by netting electric, gas, and financial contracts.
Financial Situation
For the electric utility industry, one of the most capital-
intensive industries in the world, the erosion of investor confidence
has a devastating impact on their access to capital on reasonable
terms. Higher cost of capital makes it more difficult to fund
infrastructure projects to maintain reliable electric service.
The shareholder-owned electric utility sector lost $78.3 billion in
market capitalization between December 2000 and December 2002, a 23.9
percent drop over two years. This is based upon the stock performance
of 65 shareholder-owned electric utility companies. If one expands the
coverage to include unregulated utilities, the drop in market cap is
even steeper. The EEI Index, a measure of the overall stock performance
of electric utilities, was down by 14.7 percent in 2002.
Credit Ratings
Throughout 2002 credit rating changes in the energy sector were
overwhelmingly negative. According to Standard & Poor's (S&P), the
ratio of downgrades-to-upgrades rose to 10:1 as of September 2002, up
from a 3:1 ratio in 1999, 2000, and 2001. Downgrades outnumbered
upgrades 65 to 20 in 2000. In 2001, that ratio was up to 81 to 29. This
past year, downgrades outnumbered upgrades by a whopping 182 to 15. S&P
currently rates 54 percent of energy companies as stable, down from 60
percent in 2001. The percentage of companies on negative watch has
risen to 25 percent in 2002. Currently, 18 percent of firms are non-
investment grade, as recently as 2000, this percentage was only 5%.
``These actions not only have a significant impact on cash flows, but
also add to the volatility of the sector's stock prices.
The industry is divided in terms of credit quality. The ratings of
merchant energy, trading and marketing, and some companies with a
significant degree of non-core activities have fallen drastically. By
contrast, most regulated utilities, either vertically integrated or
transmission and distribution companies, have been affected to a far
lesser extent. These companies have maintained positive valuations
through the challenging times and remain in investment grade
categories.
As companies are downgraded, they are required to post additional
cash or other collateral to meet contractual calls. A majority of these
additional cash requirements are associated with trading operations.
Ongoing corporate financing needs for any capital improvements--
distribution, transmission or generation--and general operating needs,
including scheduled debt repayment, will require ready access to
capital markets at reasonable rates. However, as 2002 progressed, this
access became more difficult as ratings dropped and fewer lenders were
willing to extend credit. The result was increased borrowing costs,
additional collateral requirements, and in some cases, the inability to
secure the level of borrowing being sought.
Trading
Companies are closing or reducing trading operations primarily to
reduce liquidity pressures, related credit rating downgrades and an
overall decline in trading activities in the industry. Furthermore,
companies are eliminating trading risks as a means to gain financial
health, contributing to an overall decline in trading activity.
Although the future for electricity trading for the shareholder-owned
electric sector remains uncertain, industry participants agree there
are strong business reasons to trade around a company's own assets, but
the business is very complex and those that remain will find a limited
number of trading counter-parties. The EEI Master Netting Agreement
also will help mitigate some of the risk around trading and improve
liquidity in the marketplace.
Generation Plants
Due to the current state of the markets and the economy, many
companies are curtailing capital spending by deferring construction
plans or canceling plants. The sector's cash crunch, increased cost of
capital, credit pressures and extremely low power prices all
contributed to the decline in construction activity.
Cancellations of power projects and delayed projects increased in
the last half of 2002 and into 2003, as the cost of capital and
refinancing escalated. According to Platts, a total of 475,085.9 MW is
scheduled to come on line between 2002 and 2007. Cancellations or
delayed announcements reached 33.8 percent or 160,491.5 MW by the close
of 2002.
Despite the ongoing cut backs in construction plans, because so
many projects are already in the pipeline, analysts believe new plant
additions for 2003 will continue to outpace electric demand growth,
which is lagging in the sluggish economy. This trend is expected to
continue through at least the end of this year. Reserve margins are
vastly higher than prior years in most regions of the country. With
economic recovery, however, will come the need for more generation to
meet a resurgence in demand growth.
Debt Restructuring
It is estimated that the power industry will require $100 billion
in refinancing of short and long-term loans during 2003. The potential
for new financing is affected by the drop in project value as power
prices collapsed and cash flows declined significantly. Additional
refinancing needs are stemming from bridge loans for acquisition
activity over the past decade and general corporate credit facilities
that are scheduled to expire shortly. Increasingly, companies are
required to pledge assets to secure new financing arrangements,
reducing financial flexibility. Companies are striving to improve cash
flow by executing asset sales, controlling costs, and minimizing
collateral calls.
what congress can do
The electric utility industry is taking significant steps to
restore investor confidence among investors and on Wall Street, and EEI
is leading an aggressive action plan for the electric industry that
embraces vastly greater transparency and best practices models in
disclosure, accounting, and market oversight.
Congress also can play an important role, including the adoption of
a comprehensive national energy policy that provides the right
incentives to grow the electricity system and sets a clear direction
for the future.
Promote Investment and Market Liquidity
Competition in U.S. wholesale electricity markets lowers consumers'
electricity bills by nearly $13 billion annually, according to the U.S.
Department of Energy. However, it also has brought major changes in the
use of, and explosive growth in the number of transactions on, the
nation's transmission systems. As a result, transmission systems are
facing dramatic increases in congestion, which threatens reliability,
makes it more difficult for new entrants to sell power in the market,
and increases costs to consumers. According to data from the North
American Electric Reliability Council (NERC), executed transaction
volume has increased 400% in the last four years, as measured by
requests for ``transmission loading relief.''
For the past 25 years, however, investments in transmission have
actually been declining an average of $81 million per year compared to
the investment needed to maintain the current level of adequacy.
Interminable delays in getting siting approvals and permits necessary
to build facilities on public lands are just some of the obstacles that
contribute to uncertainty and make it more difficult to attract
investment in transmission projects.
Meanwhile, the Federal Energy Regulatory Commission (FERC) is
moving forward aggressively with its transmission policies. In response
to FERC Order 888, shareholder-owned utilities are providing open,
nondiscriminatory access to their transmission systems. Under FERC
Order 2000, they are forming Regional Transmission Organizations
(RTOs), which will develop, operate and maintain regional wholesale
markets and infrastructure on a day-to-day basis. FERC is also seeking
to develop a standardized market design for wholesale markets. It is
critical that this design reflect the market differences in various
regions of the country, and provide the right market signals to
facilitate transmission upgrades and expansions. We are working with
FERC and state regulators to that end.
Congress can help to ensure the development of a robust electricity
market by taking steps aimed at removing barriers and supporting
incentives to enhance transmission infrastructure and other investments
necessary to support competitive, regional electricity markets:
Repeal the Public Utility Holding Company (PUHCA) and
transfer consumer protections to FERC and the states. PUHCA is
an outdated statute that stifles investment and poses a barrier
to competition. PUHCA repeal has been part of every major
electricity bill and has long been recommended by the SEC and
other federal agencies. With the current investment crisis
faced by the industry, PUHCA repeal is more important now than
ever.
Grant FERC backstop authority to help site new transmission
facilities that would relieve national interest transmission
bottlenecks identified by DOE if a state fails to act on an
application within a year or materially alters the transmission
plan. As wholesale markets become more regional in scope, new
transmission lines are needed to move power across and between
regions. It has become increasingly difficult to obtain siting
approvals from authorities in states and localities across
which these regional lines must cross, which makes it harder to
attract the massive investment needed for major transmission
projects. FERC backstop transmission siting authority would be
similar to its longstanding authority to site natural gas
pipelines. It would be used only as a last resort.
Provide for the coordination of transmission siting
activities among multiple federal land management agencies by
designating a lead agency and streamlining the permit process.
This legislation is especially important in western states,
where the predominance of federal land ownership creates a
situation where lack of coordination among agencies, or even a
single uncooperative federal land management employee, can hold
up a badly needed transmission project for months or longer.
Require FERC to issue a rule providing for innovative
pricing policies for RTOs or a transmitting utility whose
facilities are controlled by an RTO. FERC has indicated a
willingness to take some steps in this direction, but Congress
can ensure that additional measures are taken to attract the
capital to fund needed investments in transmission.
Eliminate transmission divestiture tax barriers to the
formation of independent regional transmission entities.
Federal tax laws impede the divestiture of transmission assets
to RTOs or independent transmission companies (ITCs) by
imposing a tax cost on any transfer of transmission from an
electric utility to an RTO or ITC, which has the effect of
discouraging new investment and the construction of new
facilities. DOE and FERC have expressed support for concepts
embodied in the House and Senate energy bills in the 107th
Congress that would have addressed this problem.
Reduce the depreciable lives of transmission assets from
their current 20-year recovery period to a period more
consistent with other capital-intensive industries. Speeding up
the depreciation period for transmission assets will reduce the
required rate of return for new investment because it lowers
the cost of capital. It will also increase cash flow, thereby
providing additional resources for utilities to invest in
modernizing and increasing the capacity of their transmission
systems.
Eliminate the double taxation of corporate dividends. Under
current tax law, corporate dividends are taxed twice--first at
the corporate level and then again at the individual
shareholder level. The double taxation of corporate dividends
is fundamentally unfair and is bad tax policy. Congress is now
considering a proposal to eliminate the double taxation of
corporate dividends. This proposal is extremely important to
America's electric companies, which have a long history of
paying dividends to their shareholders, and to the millions of
people who own shares in these companies.
Extend and expand the amortization of pollution control
equipment. Five-year amortization of pollution control
equipment at all generating plants--older plants (pre-1976
vintage) as well as new plants--would promote modernization or
construction of new pollution control facilities. Congress
should: (1) extend the current law's five-year amortization for
pollution control equipment to all older plants and (2) modify
current law to make it applicable to all power plants.
Amend the bankruptcy code to protect the value of cross-
commodity netting. Over the past year, EEI developed a Master
Netting Agreement designed to enable companies to better manage
their risks and improve liquidity by netting electric, gas, and
financial contracts. These in turn help promote a liquid, well-
functioning marketplace. In 2002, provisions were agreed upon
in the bankruptcy reform bill that would have addressed netting
concerns, but the bill died in conference due to unrelated
concerns.
Update the tax treatment of nuclear decommissioning costs.
All owners of nuclear power plants make contributions to
external trust funds to ensure that monies are available to
decommission the plants when they are taken out of service.
Federal tax law allows owners to deduct from taxes the amounts
contributed to these funds, but the law was designed to operate
within the structure of a fully regulated electric industry.
The U.S. Tax Code should be updated to assure that companies
can deduct decommissioning funds in a deregulated generation
market, and to ensure that the transfer of nuclear plants to
new owners can occur, and without penalty. Provisions to
accomplish these two goals were approved by both the House and
Senate as part of the energy bill during the 107th Congress.
Reform FERC's merger process by streamlining the process and
setting deadlines for decisions regarding electric utility
mergers. Utility mergers are among the most heavily scrutinized
of any industry, due to a complicated and duplicative
regulatory review process by multiple federal and state
agencies that often results in costly delays that can sometimes
drag on for years.
Promote Wholesale Competition
Congress can help promote the growth and efficient operation of
robust wholesale electricity markets by taking steps to close gaps in
federal regulation of wholesale markets and other measures.
Approximately 30 percent of the transmission system is owned by
government-owned utilities and cooperatives not subject to FERC
authority. As a result, FERC's open access rules and the market
structures being designed to make wholesale markets operate more
efficiently and fairly do not apply to these nonjurisdictional
entities. This bifurcated regulatory regime creates the potential for
gaps in the system, which means additional uncertainty.
Jurisdictional gaps in federal regulation of wholesale electricity
markets allow some market participants to exploit flaws or loopholes in
the system, which undermines the overall strength of the market.
Congress should ensure that FERC has the same level of authority to
address market power concerns relating to actions by non-jurisdictional
utilities as it has over shareholder-owned utilities:
Grant FERC authority to require non-jurisdictional utilities
that own transmission to provide nondiscriminatory open access
to their transmission facilities at rates comparable to those
that they charge themselves and on terms and conditions
comparable to those shareholder-owned utilities are required to
offer. FERC lacks jurisdiction over about 30 percent of the
transmission lines nationwide; in some areas of the country,
particularly the Northwest, a vast majority of transmission
lines are owned by nonjurisdictional utilities such as
government-owned utilities and electric cooperatives. According
to December 2002 GAO report, ``Lessons Learned From Electricity
Restructuring,''
``As a result of the lack of jurisdiction across wide
regions of the country and over significant
transmission lines connecting some areas of the
country, FERC has not been able to prescribe the same
standards of open access to the transmission system.
This situation, by limiting the degree to which market
participants can make electricity transactions across
these jurisdictions, will limit the ability of
restructuring efforts to achieve a truly national
competitive electricity system and, ultimately, will
reduce the potential benefits expected from
restructuring.''
Establish a self-regulating reliability organization, with
FERC oversight, to develop and enforce reliability rules and
standards that are binding on all market participants. With the
growth of competition, the traditional system of voluntary
reliability standards is no longer workable. Congress should
enact consensus reliability language agreed upon by
stakeholders in 2002, which also accommodates special regional
issues.
Clarify the ability of federal utilities to loin RTOs. There
is some legal uncertainty as to whether federal utilities can
join Regional Transmission Organizations (RTOs), a cornerstone
of regional wholesale market structure. In some regions,
especially the West, where federal utilities own a majority of
the transmission system, RTOs simply cannot work without
federal utility participation.
Reform the Public Utility Regulatory Policies Act (PURPA) by
repealing the mandatory purchase obligation protecting existing
contracts and providing for the recovery of federally mandated
FERC-jurisdictional PURPA costs. PURPA costs electricity
consumers nearly $8 billion annually in excess power costs, and
it has outlived its usefulness with the development of open
access to wholesale markets. PURPA reform is another item that
has been part of every major electricity bill considered by
Congress.
Grant FERC authority to order refunds from non-
jurisdictional utilities if it determines that the prices
charged by those utilities are unjust and unreasonable.
Consumers of shareholder-owned utilities should be able to
receive refunds if FERC determines that the wholesale power
prices charged by government-owned utilities and cooperatives
are unjust and unreasonable. One of the most important lessons
learned from the California energy debacle is that FERC's
refund authority should cover all market participants,
regardless of ownership structure.
Expand FERC's investigative authority and information
reporting requirements to all entities that participate in
wholesale electricity markets. For, wholesale markets to work
properly, there can be no distinction among different types of
suppliers when it comes to market transparency.
In summary, the nation's electric system is a key part of our
critical infrastructure. It is also one of the most capital-intensive
industries in the world. The electric utility sector is facing some of
its most significant financial challenges ever. Electric companies are
taking the necessary steps to restore investor confidence in the
industry. However, we also encourage your support for the measures we
have outlined to help restore capital investment in our critical
electricity infrastructure and promote the smooth and even operation of
wholesale electricity markets to the benefit of consumers and the
economy.
______
Statement of the American Public Power Association
The American Public Power Association (APPA) is pleased to submit
testimony to the Committee for its hearing on the financial conditions
of today's energy markets. APPA represents the interests of more than
2,000 publicly owned electric utility systems across the country,
serving approximately 40 million citizens. APPA member utilities
include state public power agencies and municipal electric utilities
that serve some of the nation's largest cities. However, the vast
majority of these publicly owned electric utilities serve small and
medium-sized communities in 49 states, all but Hawaii. In fact, 75
percent of our members are located in cities with populations of 10,000
people or less. Further, most publicly owned utilities are not
generation self-sufficient but depend on wholesale power purchases to
meet the retail loads of the communities they serve.
The failure of electric utility industry deregulation in California
has had and continues to have broad and far-reaching adverse effects
throughout the West. Electric utilities and their consumers in Western
states have experienced unprecedented volatility of electric prices.
Discoveries of market manipulation and abuse by energy traders and
private utilities have sent a shockwave through the industry that has
forced several energy companies to file for bankruptcy and prompted
credit downgrades of investor-owned utilities. The large drop in the
stock prices and credit ratings of energy companies further
demonstrates evidence of the electricity industry's poor financial
state. Conversely, during this crisis public power has continued to
receive strong credit ratings. Citing sound management strategies,
credit rating agencies have projected a positive outlook for public
power and as a result public power is well positioned to continue to
provide the low-cost, reliable service that has been our trademark.
Throughout the second half of the 1990s investors bought energy
company stocks based on large reported profits and strong balance
sheets. The stock price of Enron, formerly one of the nation's largest
energy traders, reached all time highs of $90 in the summer of 2000 as
Enron and other energy traders benefited from the introduction of
electricity deregulation in California. As a result of deregulation the
average price of a megawatt of electricity, which was approximately $30
before deregulation, spiked to as high as $10,000. Some investor-owned
utilities created affiliate energy trading companies as a means to
capitalize on deregulation. While these and other energy trading
companies were pulling in record profits, consumers in the West were
suffering rate increases and power outages that will ultimately cost
billions of dollars.
In 2002, the so-called Enron ``smoking gun memos'' that identified
manipulative trading practices utilized by Enron traders to drive up
the price of electricity were uncovered. In addition, it was discovered
that Enron had overstated it's earnings while at the same time hiding
debt from the public. It was soon revealed that other companies had
engaged in similar market manipulation schemes intended to increase
electricity prices at the expense of consumers. As more and more
questionable trading practices by companies were uncovered Wall Street
investors responded with an understandable anxiety that crippled the
stock values of these companies. Many investor-owned utilities are now
suffering the negative effects of their diversification efforts and the
volatility in earnings generated from their trading operations that
were spawned by deregulation.
Unlike regulators, the markets have not been slow to punish
corporate corruption. Enron is in bankruptcy-court proceedings and the
stock price of Dynegy, another large trader, which in May 2001 had been
traded at a high of $57, is now being traded at approximately $2. Other
energy trading companies, such as the Williams Companies and El Paso
Corp., have also suffered dramatic decreases in the value of their
stock. Even Duke Energy, consistently rated among the top IOUs, had its
credit rating reduced and its rating outlook revised to negative. In
2002, 182 investor-owned utilities received credit downgrades from
Standard & Poor's. The weakened financial condition of energy companies
clearly hurts both investors, who have lost billions of dollars, and
consumers, who will pay higher rates as the result of utility
companies' lower credit ratings and higher cost of debt.
Public power has not been unaffected by the Western energy crisis.
For example, public power systems that comprise the Northern California
Power Agency voluntarily participated in the state's ISO load
curtailment program and as a result were subject to blackouts, even
though they had sufficient resources to meet their own loads. In
addition, public power systems in the northwest had to increase their
electricity rates to procure long-term power to get through the energy
crisis.
However, in contrast to energy trading companies and investor-owned
utilities the credit ratings of public power systems have remained
stable. During 2002, out of 197 public power entities evaluated by
Standard & Poor's, there were only 14 downgrades. Furthermore, these
downgrades were balanced by 12 upgrades during the same period. More
than 80% of the total public power entities rated by Standard & Poor's
are rated A- and higher. In its' ``Outlook 2003: U.S. Power and Gas'',
Fitch Ratings states ``Public: power was by far the most stable utility
sector in 2002, and the outlook remains clear for the coming year.''
Standard and Poor's and Moody's Investors Service also project a strong
outlook for public power in 2003.
Credit rating agencies cite several reasons why public power has
been able to weather the Western energy crisis and maintain a stable
outlook. The previously mentioned Fitch Ratings report ``Outlook 2003:
U.S. Power and Gas'' states as an explanation of public power's
success:
``Part of public power's success reflects a conscious
decision by utility managers and board of directors to avoid
the riskiest parts of electric deregulation, such as wholesale
power marketing and merchant transactions. By nature public
power agencies tend to be a more conservative group. They view
their primary mission as serving native load customers on a
mostly not-for-profit basis.''
Public power's first and only purpose is to provide reliable,
efficient electric service to its citizens. Unlike private power
companies, public power systems do not have to serve stockholders as
well as customers. Public power's measure of success is how much money
they can keep within their communities through low rates and reliable
service, not how much can be taken out to send to distant stockholders
who are not part of the community.
As California is learning, electric prices drive local economies.
For years, public power has had a proven track record of providing
customers with lower-cost electric rates than private power companies
on a national average. For instance, residential rates for public power
systems are nearly 17% lower than for private companies, while
commercial rates are approximately 10% lower for public power. Several
factors help explain this, one of the primary ones being local control,
where public power systems are regulated by local, citizen-controlled
boards.
In a report entitled ``Stability Expected in the U.S. Public Power
Sector Despite Increasing Risk and Market Volatility'', Standard &
Poor's states that ``Public power should be recognized for having
demonstrated the ability to adapt to the heightened risk and to
continue to meet native load demands while maintaining the financial
health and operational consistency that has led to stabile credit
quality.'' The report further states, ``Public power entities
nationwide continue to adapt both operationally and financially to new
challenges.''
One example of a public power entity successfully adapting during
the Western energy crisis to provide affordable electricity to their
customers while maintaining financial integrity can be seen in the
actions of Tacoma Power. Faced with significant costs related to
wholesale power purchases, Tacoma Power was able to quickly act on a
plan to maintain financial stability. The six-point plan included a
surcharge on rates, borrowing, conservation, cost cutting, new
generation, and legislative and regulatory action. The rapid
development and implementation of this plan insured that the utility's
financial condition was maintained and system reliability was assured.
Public power utilities make good business decisions each and every
day, as demonstrated by their lower rates, reliable service and solid
credit ratings from Wall Street. Many of these decisions are made
through local democratic processes that prevent the committing of major
errors that threaten the future of a business and its customers.
Political pressure on public power officials, when it occurs, is
pressure to provide consumers with low-cost and reliable electric
service, not greater profits to stockholders.
In a report entitled ``As Electric Industry Restructuring
Continues, Municipal Electric Utility Risk Management remains a Major
Challenge'', Moody's Investors Service states that ``utility management
strategies to position for a more competitive workplace, including
improving financial liquidity and risk management'' has been a major
factor in maintaining credit stability. For example, the Sacramento
Municipal Utility District (SMUD) has implemented a financial plan over
the past several years to position the utility for competitive retail
markets. When natural gas prices rose and SMUD had to purchase power to
replace lower hydroelectric production, SMUD had the liquidity to
manage for a period of time. SMUD was able to devise a rate
restructuring that established a rate surcharge to maintain its sound
financial position and to replenish a rate stabilization fund to be
available for future market disruptions.
Because of their solid management and commitment to the core value
of serving all their customers, public power utilities were able to
survive the turmoil of the Western energy crisis. While some Western
public power utilities were hurt by the skyrocketing wholesale power
prices during the energy crisis, they were able to minimize the effect
on their consumers and remain fiscally responsible because of their
flexibility and local control. The overall performance of publicly
owned utilities has clearly shown that the traditional concept of not-
for-profit operation subject to local control works. As the Committee
considers measures to restore the financial condition of energy markets
APPA urges opposition to any efforts that would impair the principle of
local control that has allowed public power to serve its members for
over 100 years. Further, it is critical that Congress understand the
lessons of the Western energy crisis before proceeding with changes
affecting the $200 billion wholesale electric utility market. Enacting
electricity legislation without full understanding of the Western
energy crisis will almost surely result in unintended adverse
consequences that will cause further harm to energy markets as well as
consumers.
______
Statement of Kara M. Silva, Vice President, MBIA Insurance Corporation
Thank you, Mr. Chairman and members of the Committee for the
opportunity to provide testimony regarding the financial condition of
the electricity markets. MBIA believes that regulators and the U.S.
Congress can play an important role in helping to address the current
state of the electricity markets. Much can be done to help ensure that
utilities are financially healthy, so that the markets, investors, and
consumers will not be further harmed.
In my testimony, I will describe provisions of current law that may
serve as important safeguards for maintaining the financial health of
utilities. I will explain why it is vital these provisions not be
repealed, but rather strengthened. Finally, I will make recommendations
for legislative changes to guard against the further weakening of
utilities' financial position.
DESCRIPTION OF MBIA
I am Kara Silva, a Vice President of MBIA Insurance Corporation.
Because MBIA tracks the performance of utilities so closely, we are
often among the first to see problems within this sector. MBIA
approaches the critical issues facing the electricity industry from its
perspective as an insurer of the bonds of many domestic electric
investor owned utility companies (``IOU''), and as a representative of
bondholders' interests. The financial distress and increased risks
facing the industry are serious problems that must be addressed.
MBIA is the premier financial guaranty insurance company in the
world. We are a Triple-A rated monoline financial guaranty insurance
company regulated primarily by the New York State Insurance Department.
As opposed to multiline insurance companies, monoline financial
guaranty insurance companies engage in only one line of insurance--
financial guaranty insurance. Our Triple-A ratings from Moody's
Investors Service, Standard & Poors and Fitch enable us to offer
qualified issuers the ability to borrow money in the public markets at
the lowest possible interest rate. Once these debt obligations are
sold, MBIA guarantees--unconditionally and irrevocably the timely
payment of principal and interest to bondholders. We effectively step
into the shoes of the bondholders and represent their interests in the
capital markets.
I am responsible for managing MBIA's global utility portfolio which
consists of over 1,300 issuers worldwide and which has a total par
value of over $63 billion. My primary responsibilities include
monitoring this portfolio to identify and mitigate credit decline of
financially troubled obligors.
profound changes in iou sector: financial distress and increased risks
The domestic electric investor-owned utility sector has undergone
profound changes in recent years. Many IOUs are experiencing financial
distress because of aggressive expansion sanctioned by recent
deregulation. The regulatory safety net has not performed as expected.
And the electric IOU sector has experienced several shocks due to ill-
conceived restructuring plans and instances of corporate malfeasance.
As a result, the risk profile of the electric IOU sector has
changed significantly. What formerly were ``safe'' utility credits are
now performing like corporate credits in other sectors. In order to
understand the effects of this change on the ability of IOUs to access
the capital markets, it is important to focus on the legislative,
corporate, regulatory, business and financial risk points. In each of
these areas, exposure to risk has been heightened.
From a legislative standpoint, the sector faces risk as states
enact inconsistent legislation and utility customers that are most at
risk have open access to choose alternative providers. The ability to
recover stranded costs and the sale of generating assets all increase
risk exposure as restructuring occurs.
On the corporate side, we carefully monitor mergers and
acquisitions--particularly as utilities expand into deregulated or
international lines of business. We have seen an unusually high number
of distressed parent companies, as well as heavy litigation and
governmental investigations into corporate activities.
Regulatory risk at the state level comes from rate caps combined
with the inability to pass through costs, as well as from differences
in state regulatory decision-making. On the federal level, regulatory
risk comes from the possible repeal of the Public Utility Holding
Company Act of 1935 (``PUHCA'') and the potential elimination of the
Federal Energy Regulatory Commission's (``FERC'') merger authority.
Finally, the sector faces business risks from capacity issues, a
core business highly impacted by weather and the economy, and a high
cost structure with impending competition--not to mention fuel supply
and environmental costs.
These factors combine to create significant financial risk in this
sector. Poor non-utility investment decisions have led to weak balance
sheets. Weak balance sheets have led to liquidity problems and
downgrades by the rating agencies. Downgrades have led to collateral
calls and other rating-related triggers that accelerate the liquidity
problem. Furthermore, overbuilt capacity reduces the value in planned
asset sales meant to reduce debt and improve liquidity.
Weak balance sheets, poor liquidity and uncertainty of
restructuring plans have made access to the capital markets very
difficult and very expensive. An overall theme has emerged from the
current market dynamics: it is difficult to have regulated and non-
regulated activities in the same corporate family. Regulators are
having to adapt their current authorities to the emerging challenges
presented by the co-existence of utility and non-utility affiliates,
and it is unclear at this point whether those authorities will be
sufficient in all instances. Moreover, some utilities do not want to
diversify into non-regulated business.
ROLE OF REGULATORS: REGULATORY ``CHECKPOINTS''
MBIA has urged state commissions and other regulators to exercise
their full authority toward fashioning realistic solutions. The most
difficult dilemma for regulators is the jurisdictional context in which
agencies must operate to protect consumers. Jurisdiction over corporate
structure, finance, and governance is shared by the FERC, Securities
Exchange Commission (``SEC''), and state regulatory commissions--and
the jurisdictional split is not easily discernible. A single corporate
transaction might require authorizations from more than one agency.
When a utility is financially troubled, there are several
regulatory ``checkpoints'' that can serve as warning signals to
regulators and to the public that regulatory intervention might be
warranted. These checkpoints include regulatory proceedings at FERC,
the SEC, and before state commissions. Regulators have the opportunity
at these checkpoints to assure that the proposed action by the
utility's corporate family will not harm the utility's financial
position.
However, while state and federal regulators have the ability to
address many problems when utilities are financially troubled, their
abilities sometimes stop short of what is needed to reach all trouble
spots. Jurisdictional limits and uncertainty regarding jurisdiction can
in some instances be a barrier to needed regulatory action. MBIA
believes that Congress should step in to close regulatory gaps and add
certainty to regulatory jurisdiction, to help ensure that the financial
health of regulated utilities is restored and maintained. MBIA would
urge the Committee to strengthen, rather than weaken, the regulatory
review performed at these checkpoints.
FERC
At least two of the regulatory checkpoints are at FERC--electric
utility applications filed under Sections 203 and 204 of the Federal
Power Act.
Section 203
Section 203 requires FERC's approval of any sales or other
dispositions of FERC-jurisdictional facilities that exceed $50,000 in
value.\1\ This includes mergers and acquisitions, certain divestitures,
and corporate reorganizations. Given that many parent energy companies
are seeking to shore up their balance sheets and those of their non-
regulated subsidiaries, and utilities are merging with more risky non-
utility counterparts, such as power marketers, these kinds of
transactions warrant careful monitoring.
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\1\ 16 U.S.C. Sec. 824b.
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At the moment, many parent companies may be looking to the
regulated utility to help improve balance sheets, and questions arise
whether Section 203 transactions will always be in the best interest of
the regulated utility. At this checkpoint, FERC may wish to consider
whether the Section 203 transaction helps, hurts or is neutral to the
utility. Intervenors, such as state commissions and other stakeholders,
may also add to FERC's deliberations.
For example, in the case of a sale of jurisdictional assets, it is
appropriate for FERC to question, as it has in a recent letter to an
energy company, how the proceeds of an asset sale will be allocated
within the corporate family, and whether the regulated utility will be
left holding indebtedness related to the asset that has been sold.\2\
Such scrutiny insures that the utility subsidiary does not become laden
with debt unrelated to its own assets and activities.
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\2\ El Paso Corp., Docket Nos. FA02-36-000 and IN02-6-000, Letter
Order (unpublished) issued Feb. 26, 2003.
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Another example is the acquisition of a utility by a non-utility
corporation, such as a diversified company or power marketer. MBIA
believes that FERC can, and should, review such acquisitions to ensure
that the credit and financial strength of the utility is not weakened
by its induction into a corporate family of more risky businesses. If
FERC were to require as a condition to such a merger the establishment
of appropriate corporate and financial separations--so-called
``ringfencing''--utility investors and consumers would be safeguarded
from harm.
Broadly speaking, ringfencing is simply an effort to wall off
certain assets or liabilities within a corporation. For example, this
can be done by creating a new subsidiary, or by limiting or prohibiting
internal financing to an existing subsidiary. Ringfencing has been a
common practice among businesses with large liability exposures, such
as tobacco companies, to protect less risky affiliates. But MBIA
believes that thoughtfully applied ringfencing techniques can be
effective tools for regulators to protect the public interest by
shielding core utility assets from affiliated non-utility businesses.
Standard & Poor's views the Oregon Public Utilities Commission
(``OPUC'') as being among the most supportive of utility credit quality
in the country--in large part because of the restrictive ringfencing
conditions imposed on Enron when it acquired Portland General Electric
Company (``PGE'') in 1997. In its decision-making process, the OPUC
specifically considered the effect of the acquisition on PGE's
financial structure and utility assets.
Among the OPUC's conditions were the maintenance of a 48 percent
equity level at PGE and advance notification of special or large
dividends to Enron. In addition, PGE was required to maintain a
separate accounting system. As a result of these and other conditions,
PGE was one of only a handful of Enron assets to emerge intact after
Enron's bankruptcy. While PGE's future is still uncertain, its
corporate credit rating is significantly higher than would be expected
as a result of the ring-fencing criteria.
Under the Federal Power Act, FERC cannot approve proposed Section
203 transactions unless they are ``consistent with the public
interest.'' In making this determination, FERC currently considers
three factors: the effect of the proposal on rates, the effect on
competition, and the effect on regulation. We believe it to be in the
public interest, and consistent with the three factor test, for FERC to
consider the effect on the health of the regulated utility, and to
require ringfencing as a condition to mergers in which utility and non-
utility businesses are mingled.
The current state of the electricity industry makes it critical for
FERC to have clear, strong authority to review mergers and other
dispositions of facilities so that IOUs, and their ratepayers and
shareholders are not harmed. FERC has the expertise and experience
necessary for the job. And as the number of mergers, corporate
reorganizations, and divestitures increases in the current financial
climate, FERC must have clear authority to do so. MBIA recommends that
Congress enact legislation that would clarify FERC's authority to
protect the financial health of the regulated utility, in the context
of Section 203 transactions. And in contrast, the repeal of Section 203
as has been advocated by some would remove a significant tool to
protect utility financial strength.
Section 204
Applications filed under Section 204 of the Federal Power Act also
serve as a regulatory checkpoint at FERC, where regulated utilities
must obtain FERC's approval for debt and equity offerings.\3\ FERC, in
its recent Westar Energy, Inc. order, has revised its criteria for
approval of Section 204 applications.\4\ FERC's new policy attaches
certain restrictions on all public utility issuances of secured and
unsecured debt authorized by FERC. MBIA commends FERC on its action in
this important case, because these conditions are aimed at protecting
utilities from the cost and risk of non-utility debt. The Westar
conditions will provide important safeguards at least for those
issuances that come before FERC for approval.
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\3\ 16 U.S.C. Sec. 824c.
\4\ Slip op., Docket No. ES02-51-000 (issued Feb. 21, 2003)
(``Westar'').
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However, not all debt and equity issuances are subject to FERC
review. In the case of registered holding companies, the SEC is the
agency with such authority. And, to the extent a state regulator
reviews issuances, no application before FERC is necessary. Thus,
Section 204 is at present not a complete safety net for issuances that
pose risks to utility financial strength.\5\
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\5\ The Kansas Corporation Commission (``KCC'') also has been
proactive in scrutinizing corporate applications with a view toward
shielding utility investments from poorly performing non-utility
ventures. The KCC recently used its authority over corporate governance
and debt management to require an application to transfer its utility
division to a utility-only subsidiary, and ordered institutional
safeguards to separate the utility and non-utility businesses. This
decision preceded, and complemented, the FERC's decision on Westar's
application to issue securities, and effectively prevented the utility
from assuming non-utility debt.
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SEC
In addition to FERC, the SEC is another federal venue that provides
regulatory checkpoints for troubled utilities. The proposals of multi-
state utility holding companies, or holding companies that are
registered under PUHCA, must often be reviewed by the SEC, under
PUHCA's requirements. Utility holding companies that are exempt from
PUHCA's registration requirements are subject to much less regulation.
One of the areas within the SEC's jurisdiction is review of registered
holding companies' proposed investment in non-core, non-utility
businesses. Poor non-utility investment decisions have led to weak
balance sheets in the industry. While registered company acquisitions
of some non-utility businesses are exempt from the SEC's review, such
as acquisitions of exempt wholesale generators and foreign utility
companies, the associated financing of such diversified investment must
usually be approved by the SEC.
Financing in the form of the issuance and sale of securities for
non-utility investment is subject to SEC approval under Sections 6 and
7 of PUHCA.\6\ Under PUHCA, the SEC must not allow a proposed financing
of non-utility investment if the terms of the financing are
``detrimental to the public interest or the interest of investors or
consumers.'' Consideration of the potential impact on the regulated
utilities in a holding company system should fall squarely within this
inquiry. Intervenors, such as state commissions and other stakeholders,
can add to the SEC's deliberations.
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\6\ 15 U.S.C. Sec. Sec. 79f and 79g.
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Proposed registered holding company acquisitions of non-utility
businesses, that are not subject to any special exemption from SEC
review, must be reviewed under Sections 9 and 10 of PUHCA.\7\ Together,
Sections 9 and 10 require that acquisitions of interests in
businesses--not just utility businesses--must not be ``detrimental to
the public interest or the interest of investors or consumers or the
proper functioning of the holding company.'' Here again, the impact of
proposed non-utility investment on the system's regulated utilities can
be considered. State commissioners and others can file comments on
these proposals, as well.
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\7\ 15 U.S.C. Sec. Sec. 79i and 79j.
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The SEC also has jurisdiction over mergers and acquisitions and
certain affiliate transactions proposed by utility holding companies.
However, the SEC's regulation of non-utility investment is often an
area where the SEC has exclusive jurisdiction, and poor non-utility
investment decisions represent a risk factor in the electric utility
industry.
MBIA has encouraged state commissions and other stakeholders to
file comments in SEC proceedings, to present any concerns and questions
about non-utility ventures. However, the fact remains that the SEC has
routinely approved most applications filed under PUHCA. But, given that
the SEC often has exclusive jurisdiction to examine these acquisitions
and financings, it is important that concerns about non-utility
investment be effectively addressed.
The proposals of multi-state holding companies, or holding
companies that are registered under PUHCA, are of particular importance
to state utility regulators since states tend to have less regulatory
authority over these multi-state entities. Moreover, even if a holding
company is exempt from PUHCA due to its status as a primarily
intrastate entity, this status does not guarantee that state
commissions will be able to effectively monitor or regulate the non-
utility business of utility holding companies, even under current law.
The prospect of PUHCA repeal has taken on a different aspect in
light of the deterioration of the financial strength of utilities. In
recent years, PUHCA repeal has been viewed as the removal of a barrier
to deregulation, with state regulators and FERC presumed to step in and
fill the gap. However, the financial distress experienced by the
utility industry even with PUHCA in place raises a compelling question:
without PUHCA, what limits will exist on the ability of holding company
systems to shift debt and risk to utilities and away from non-utility
subsidiaries? Although not strenuously enforced in recent years, PUHCA
has served as somewhat of an inhibiting factor on utility investment in
non-utility businesses--and non-utility investment in utilities.
Without the constraints of PUHCA, FERC and state regulators will be
hard-pressed through existing regulatory authority to achieve the level
of effective corporate and financial separation MBIA believes is vital
to the health of utilities. Even with PUHCA, state regulators have had
to struggle to protect utilities. For these reasons, MBIA favors PUHCA
reform, rather than repeal.
To the extent that there is an effective ``gap'' in regulation of
non-utility diversification, we believe that Congress must fill the gap
and ensure that regulated utilities are not harmed by the non-utility
side of a holding company's business. Congress should not prohibit the
intermingling of utility and non-utility businesses in the same
corporate family, but it should enact legislation that places
conditions on holding company acquisitions and financings of non-
utility investment, to help to ensure the financial health of the
regulated utility. MBIA supports the transfer of PUHCA's consumer and
investor protections to FERC.
For instance, Congress should empower the federal regulatory body
with authority over holding companies with the authority to require
that the utility subsidiaries be properly financially separated from
non-utility affiliates. To the extent that a utility merges with,
acquires or is acquired by a company with non-utility subsidiaries,
federal regulators should be empowered to condition such transactions
with the requirement that state regulators of utilities within a
holding company system have sufficient authority to protect the
regulated utility from harm that non-utility affiliates can cause. FERC
should have the authority to review transactions between a utility and
its affiliates, to guard against cross-subsidization. Legislation
should require that state commissions and/or FERC have sufficient audit
authority, and full access to the books and records of the holding
company and its entities. In addition, legislation should require that
holding companies maintain separate books and records for non-utility
and utility entities.
Whether or not PUHCA is ultimately repealed by Congress, we believe
it is important that such requirements be in place. Proper monitoring
and treatment of non-utility ventures can only be achieved if the
appropriate regulators have the tools to be effective.
Congressional Action Needed
In closing, I would like to commend the Committee for recognizing
the importance of addressing the financial distress in the utility
industry. A financially imperiled utility erodes investor confidence,
which can lead to higher rates and service and reliability problems.
Federal and state regulators have a role to play in helping to ensure
the financial health of utilities, but Congress must also act to
provide regulatory certainty and fill any regulatory ``gaps.''
MBIA recommends that Congress enact legislation to accomplish the
following:
Clarify FERC's authority to protect the financial health of
the regulated utility, in the context of Section 203
transactions under the Federal Power Act.
Reform PUHCA and transfer its consumer and investor
protections to FERC, including authorities related to
securities issuances, mergers and acquisitions, affiliate
relationships, and the financial separation of the utility from
non-utility affiliates.
Help ensure that state commissions that regulate the rates
of utilities within a holding company system have sufficient
authority to protect the regulated utility from harm that non-
utility investment can cause. Conditions on holding company
acquisitions and financings of non-utility investment should
include the following:
Requirement that state commissions have sufficient audit
authority.
Requirement that state commissions have full access to the
books and records of subsidiaries within the holding company
system, and the authority to review the relationships of
utility and non-utility subsidiaries.
Require that holding companies maintain separate books and
records for non-utility and utility entities.