Genco Risk: "Location, Location, Location"Vinod Dar's recent article, "Competition, Convergence . . . and Cashflow? The Power Business in the Next 20 Years" (Apr. 1, 1996, p. 31), highlighted some of the risks inherent in investments in new power generation plants in a restructured electric industry. Dar discussed issues related to liquidity, credit quality, and foresight, but touched only briefly on the importance of "positioning" - perhaps the most critical issue in determining the financial viability of a new power generating unit.

Now that the California Public Utilities Commission has encouraged California's three major investor-owned utilities (IOUs) to divest themselves of a sizable portion of their existing fossil plant - to avoid a concentration of market power in generation - certain questions arise: What is an old generating unit worth? Which plants will the IOUs offer up?

These questions call to my mind the three basic tenets of the real-estate market: location, location, location. A gas-fired unit's

installation cost, fuel-price risk, and the market price for its "product" are all related to its location.

A new unit, particularly in California, must meet a variety of siting and permitting requirements that add to the overall cost of installation. These costs rise dramatically as the site moves closer to a major load center. Existing units may even require expensive retrofits to make them environmentally acceptable. Thus, some investors may find it more profitable to locate a new generating unit farther from a load center, since the cost of transporting the unit's power to the load may more than offset the installation premium at a closer locale.

Similarly, the price of natural gas delivered to the burnertip will also affect a unit's profitability. While natural gas "choke points" may not prove troublesome in the near term, given existing gas pipeline capacity, power plant owners still must consider appropriate fuel-risk strategies for 20 years out, when natural gas curtailments may reappear. Will easy access to storage or backup fuel supply provide a sufficient hedge to allow a generating unit to make only spot-market purchases of gas? Investors may find certain fuel-risk strategies less expensive if a unit is located closer to the gas production fields in Canada and the Midwest.

Finally, the location of the unit will impose a tremendous impact on the revenues received for its generated power. Is the unit located downstream or upstream of an electric transmission "choke point"? Can the unit provide needed voltage support and, more important, get paid to do so? The prices paid for unit ancillary services will affect the viability of older units located near load centers. By contrast, revenues from ancillary services for a unit located far from a load center may be negligible. This fact, when combined with a higher electric transportation cost, may undo a proposed project.

Here's another point to consider: How will the owners of the gas and electric transportation systems respond to existing and future choke points? If a generating unit located downstream from an electric transmission constraint receives a premium for its power, the owner of the electric grid could end up as a competitor. A transmission system upgrade could eliminate this premium, leaving the unit's power priced more as a commodity.

Kevin C. Kozminski

Transmission Planning Department

Pacific Gas & Electric Co.

(The opinions expressed above belong to the author - not Pacific Gas & Electric Co.)

Purchased Power:

"I Told You So!"

Robert Rosenberg's article, "Purchased Power: Risk Without Return" (Feb. 15, 1996, p. 36), proves that I am middle-aged, even if I sometimes vainly consider myself young.

During the late 1970s and early 1980s, when I was in my 20's, consumers and environmentalists supported flow-through accounting of utility income taxes instead of normalization. We argued that if utilities continued to build big, expensive power plants under normalization, they would reap huge rewards from "phantom taxes" - taxes collected from ratepayers, but not paid to the government. However, if utilities ever did build less, they would accrue large bills to pay back to ratepayers. Ergo: Rate base rewards would provide a strong incentive for

utilities to build power plants instead of investing in energy efficiency.

We lost that battle, thanks to Ronald Reagan's 1981 tax act; tax normalization is now the law of the land. I myself had nearly forgotten that debate, until I saw a sidebar in Mr. Rosenberg's article on the dangers of declining rate base: "Deferred taxes will reverse and suddenly come due, as the utility pays more in cash taxes than it collects through rates."

Rosenberg contends that competitive generation is bad for electric utilities. Among other consequences, it increases financial risk by forcing utilities to pay off their deferred taxes. Those increased costs and risks should, in Rosenberg's opinion, count against purchased power in any decision about whether utilities should build their own plants or buy what they need.

So, the consumers and environmentalists of the late 70's were largely right: Utilities became addicted to cash from phantom taxes. Now that growth has slowed and generation has become competitive, they may have to repay those phantom taxes. That is why utility supporters attempt to squelch competition in generation with tales of woe about the risk of purchased power - so that utilities can build more plant, keep their rate base up, and pay less of the phantom tax money back to the ratepayers who loaned it to them in the first place years ago.

So I am feeling my age today, along with a little bit of the grumpiness inherent in the aging process. I must really be 43 after all, because "I told you so - over 15 years ago!"

.Pp

William B. Marcus

.Pp

Principal Economist

.Pp

JBS Energy, Inc.

.Pp

West Sacramento, CA

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