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The New Venture Capitalists: Utilities Go Shopping for Deals

How gas supply and price disruptions now outweigh Big earnings potential plus an energy-related focus are prerequisites when AEP and Cinergy sort through investment projects.
Fortnightly Magazine - December 2000

utilities also face possible legal and regulatory problems. For one, rules impose a number of constraints on utilities that most other organizations do not face. This issue is particularly important if the utility will be a trade partner of the new affiliate, as opposed to just a "hands off" investor. State regulators are wary of affiliate transactions that may pose risk for retail electric customers.

Two affiliate issues affect the way utilities deal with their affiliates. The more general of the two is defined by developed by the state regulatory agency. These rules may limit the degree of utility ownership allowed and other organizational and communications issues that arise between the company and its affiliate. The second issue is specific to of the products and services that utilities and their affiliates trade. Not all venture capital investments involve the latter issue, because the affiliate may not be a trade partner with the utility but rather a true investment play.

Ken Costello of the National Regulatory Research Institute agrees that affiliate rules may play an important part of the utility-affiliate relationship. For utilities that trade goods and services with their affiliates, many state regulators have adopted transfer pricing rules to circumvent potential cost-shifting and cross-subsidization that may harm the utility's ratepayers. A rule of thumb is that the utility pays the of market price or cost for goods and services purchased from the affiliate, leaving the affiliate to bear the of market price or cost when paying the utility for goods and services. This rule keeps ratepayers from unfairly subsidizing the venture, but can be a serious burden for startup companies with partial utility ownership.

Cinergy's Kushman has not yet run into any problems with affiliate interest codes of conduct, but he says that they could put his utility at a disadvantage. He explains, Cinergy Ventures was established as a non-regulated unit and invests in minority equity stakes in order to avoid the constraints that affiliate rules place on utilities. "When implementing the technology of a portfolio company, Cinergy Ventures understands the prohibitive nature of market price/cost transfer pricing policies in some states. Tactically, their investments are structured such that portfolio companies' business models will not be restricted by these affiliate rules, while protecting the strategic value derived by having a progressive utility partner."

Positive Outlook

Despite the potential regulatory and business risks associated with venture capital investing, the outlook for both the quantity and quality of deals is encouraging. Armed with corporate resources and support, the utility venture capitalists are geared up to enhance their portfolios while adding strategic value to their parent companies. The ultimate results will be known after successful integration of the new investments within the organization, and after overall returns for the venture capital portfolios are calculated. After that, the impact on the utility stock price is up to the Wall Street experts—perhaps resulting in re-classification of several key power company players in a more risk-and-reward-oriented sector. Only time will tell, but then, that is the mantra of the venture capitalist.

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