It's no surprise that traditional utilities are now fashionable with Wall Street.
With merchant generation and energy trading gone bust, bankers, analysts, and fund managers at the 37th Edison Electric Institute Financial Conference, held last month in Palm Springs, Calif., were falling over themselves to find those regulated gems overlooked during the energy merchant boom years.
"How much of your earnings came from the regulated-side? When is the last time you had a rate case? Do you think that will be allowed? What is your dividend?" The financial analysts attending the meeting asked those questions and more. Even some utility CEOs and CFOs got into the act.
It seemed that every firm worth its salt offered up a pie chart with bold claims showing just what share of the bottom line had come from regulated earnings. Count those companies as the lucky ones.
By contrast, the utilities at the conference with under-performing merchant or trading operations were greeted with a level of suspicion that you might otherwise reserve for an unindicted co-conspirator. Consider a question posed to TXU.
"When did you know your energy trading and merchant operations in Europe were under-performing?" TXU had reported significant losses to its European subsidiary quite abruptly in October.
Of course, everybody by now has heard that TXU sold its UK assets, and is now one of many U.S. companies that has exited the European and the UK markets recently.
But confidence in U.S. utility companies-their ability to show a profit in competitive markets-has now been shaken, perhaps irrevocably.
Earlier, when they had announced their overseas projects, U.S. utilities had explained that they were exporting their business models.
Now that those exports have failed, many experts have begun to question whether the skills to compete were there to begin with. Certainly, many analysts at the conference wondered whether more earnings surprises might now show up in TXU's domestic operations. Naturally, TXU has said repeatedly in press releases that its U.S. operations are solid.
But two fixed-income executives I met turned positively livid at what had happened to TXU, as they had counted on that company in their pension fund portfolios. It was supposed to be a widow's and orphan's stock. They said they felt let down, as TXU seemed to them so abrupt and even careless in how it revealed the problems in its European subsidiary.
(In fact, the very public problems of many U.S. energy firms are having a chilling effect on liberalization and privatization efforts worldwide, says one expert. The European Union has backed off on addressing liberalization until 2006, and the opening of French energy markets is not the hot button issue it once was.)
Others I spoke to had bought bonds in Allegheny's utility subsidiary. And just as with TXU, they expressed dismay that financial problems at the parent company level had filtered down to the utility, creating another problem child with cause for concern. And if traditional rate-base regulation no longer offered any safe harbor within a diversified holding company structure, then what if anything was safe anymore at a vertical energy firm? Last but not least, I ran into a hedge fund analyst who told me he had bought up some distressed debt from Aquila on hopes the company would recover. But he said that after hearing the CEO speak, he was still concerned about recovering his investment. Like many involved in merchant generation fire sales, he worried whether enough buyers would emerge for those properties. And whether Aquila could raise the money fast enough to improve its credit profile.
Certainly, the mood was rather grim. One banker likened the scene to 1987, when the one-day drop of 500-plus points on a then-much lower Dow had occurred right during the middle of that year's EEI Finance meeting. Now, 15 years later, three different companies had approached him about exploring reorganization or bankruptcy plans as an option. Or so he told me.
The only company that seemed to be a bright star at the conference was Southern Company, due to its stable earnings. (Not to mention its earlier and well-timed merchant gen spinoff to Mirant.)
On the way back to the airport, I shared a cab and split the fare with a CEO from a midwestern utility. Hearing that we had come back from an energy conference, our driver piped in to join our conversation about competitive energy markets. Why had she paid nearly $3,600 per year to Southern California Edison (SCE) for electricity, she wanted to know, when the Imperial Irrigation District, a municipal utility that served a region less than five miles from where she lived, charged 50 percent less.
"What could possibly explain the difference?" she asked.
We could have told her about how competitive markets in California weren't designed properly, but she would not have listened. In her mind, the game was rigged. It seems that when she had phoned SCE to ask about her bill, the company had assured her situation was not all that much different from that of other SCE customers, especially those living in the desert. During the California crisis, an SCE spokesman had explained, a tiered rate structure was developed to reward conservation. Those that used the most power would pay the most. And more than that, said SCE, the California experiment with competition had forced costs up for everyone-everyone, it seems, but those lucky enough to live among the irrigated citrus groves and vegetable farms of the Imperial Valley.
But turning SCE into a municipal utility district-as some California politicians and regulators have called for-would not be the answer either, said the spokesman. That would not change prices, he said, because it has become more costly today to create a municipality than it was half a century ago, when the state's irrigation districts were formed.
But what's all that to a taxi driver in Palm Springs? To us, sitting in the cab, on the way to the airport, it was painfully clear: California's energy experts failed to learn from their brethren in the deregulated airline industry.
Robert L. Crandall, former CEO and chairman of American Airlines, speaking at the EEI Finance conference, put his finger on the main problem with electric deregulation. The most important thing that happened in airline deregulation, he said, was that prices came down-something the California model was not able to accomplish. Crandall spoke of how there was fierce resistance to airline deregulation from many in Congress, who feared that voters living in remote areas would not be served.
But what kept the momentum going on airline deregulation, Crandall said, was that the airlines were able to win a large constituency in the country through their lower fares, and won an even bigger constituency as the prices continued to fall.
Of course, as the emphasis returns to the rate base, one might ask how regulated utilities will improve on the moves they made as monopolies some 20 years ago. They certainly made some very costly building decisions that raised rates considerably in some states. Let's not forget the billions paid off in stranded costs. Therein lies the question that started us on the road to restructuring.
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