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Investor Beware: Don?t Overestimate Financial Returns In a Restructured Electric Industry

Fortnightly Magazine - June 1 1998

reversals of "policy" (em always with resulting damage to investors. One need only look at the unwillingness of New York state to permit Niagara Mohawk to recover the stranded cost associated with cogeneration buy-back requirements. The "negotiated" solution to this state-mandated, high-cost power has forced NiMo to hand over a large fraction of its equity to cogenerators. In New Hampshire, we have the spectacle of a state that first helped bring its home utility out of bankruptcy. The acquiring company relied upon a firm, written contract guaranteeing recovery of certain costs, but now appears unwilling to honor that contract. The result? The acquiring utility has had to go into federal court simply to get New Hampshire to honor its word.

This backdrop appears unsettling not only in its anecdotal caveats, but also because of what it implies for the transition to competition. It is unlikely that we will see anything like a rapid move to markets in the electric energy business. Almost certainly the transition will occur over an extended period with heavy oversight, both regulatory and political.

Consider the airline or telecommunications industries. Deregulation of the U.S. airline industry was signaled by dismantlement of the Civil Aeronautics Board in 1979. In 1984, we saw the start of deregulation of the telecom industry (em a restructuring which 14 years later has not generally been undertaken at the state level. These two industries are often singled out when discussing the pending restructuring of the electric industry. However, they provide poor models for projecting electric restructuring or the opportunities and risks for investment in a restructured generation market.

If state governments remain involved in electric restructuring, their work certainly will not parallel what occurred in the airline industry, with its quick dismantlement of CAB. Instead, the record to date at the state level implies a transition that will likely prove to be far slower and more intrusive, for example, than the more rapid attempts at telecommunications restructuring undertaken so far at the Federal Communications Commission. (In fact, a number of state regulatory commissions already are suggesting a need for more staff to oversee electric industry restructuring.) It is this ongoing state involvement that will inevitably exert a substantial negative force on the ability to earn satisfactory returns in the electric generating business in many parts of the U.S.

A number of behaviors at state level could raise serious concerns, such as:

•  Chronic failure by state policymakers to follow established policies (em even their own.

•  Unprecedented involvement by an entrenched state "consumer advocacy" infrastructure.

•  Regulatory constraints on electric demand growth.

•  Ongoing state control of electric distribution companies.

The well-documented cases of the failure of states to live by commitments made either under the "regulatory compact" principle or even underwritten contract obligations are not meant to suggest a lack of honesty or trustworthiness of individual regulators. Rather, these cases underscore the high risk of systemic inability to live up to past commitments, even if the commitments represent state mandates and particularly if they are long term in nature.

The regulatory process is