T+D Out, G+D In
Why not keep the power plants and sell off transmission instead?
U.S. utilities made a big mistake in selling off their power plants. They should have held those plants and sold off their transmission lines instead. That's what Ed Tirello says, the financial analyst now at Deutsche Bank Securities Inc., who made his mark about a decade ago with his famous quip of "50 in Five"-that mergers would bring the number of U.S. utilities down to about 50 companies within five years. He was right, back then, but a little off on his timing.
Tirello adds that state regulators at the public utility commissions perhaps should share part of the blame. After all, in many cases it was the PUCs that forced utilities to divest their generation assets-or at least their fossil-fired plants. They wanted to establish a fair price for the plants to help gauge the extent of stranded costs.
The PUCs also wanted to deflate market power. Divesting generation would segregate the production process from the monopoly wires highway that transports the product.
But Tirello says the PUCs goofed. Speaking in late May, Tirello pooh-poohed any PUC concern over market power. "Market power appears to be a federal story," he said. Tirello seemed to feel it was clear all along that federal regulators had special plans for transmission-to place it in the neutral hands of an independent system operator (ISO) or regional transmission organization (RTO). So the utilities never needed to sell their plants to separate the grid from generation. It would have happened anyway.
Can Tirello be right again? Is the pure "wires utility" doomed to extinction?
DTE Energy, parent company of Detroit Edison, is one utility that is betting on Tirello's vision. On May 19, DTE applied to the Federal Energy Regulatory Commission to sell off its transmission lines to a new company, to be known as the International Transmission Co. But DTE would hold on to its power plants and its monopoly franchise as the local distribution company. It would become a combined distribution utility and power producer.
Don't think T+D. Think G+D.
SO HOW FARES THE WIRES-ONLY UTILITY? At press time, the British transmission giant National Grid Co. reportedly was mulling the idea of offering $4 billion to purchase GPU, one of the first U.S. electrics to advertise a strategy of exiting generation and proclaim itself a wires-only utility.
On June 7, the day the Manchester Guardian reported the story, GPU stock closed at $28.75, off its high of about $44.50 during the prior 12 months. GPU closed at $29.44 on June 12, at a price-earnings ratio of 9.06, off some 30 percent over that 12-month period vs. the universe of U.S. electric utilities, according to CBSMarketWatch.Com. GPU's depressed stock price seemed to make it an attractive target. (Yet GPU stock did match the electric industry's 20 percent stock runup over the three months from early March to early June, coinciding with the recent tech-driven crash in the NASDAQ index.)
Speaking two weeks earlier, on May 23, at the World Forum on Energy Regulation in Montreal, Tirello even then had begun to question why foreign utilities were so eager to acquire U.S. utilities that had put their faith in a wires-only strategy.
"Scottish Power, PowerGen, and National Grid all made mistakes with their U.S. acquisitions," said Tirello. Instead, he suggested, "The big utilities will be controlled by the oil companies." In other words, Tirello believes that control of the utility sector will pass to companies with big investments on the production side. He sees evidence for that in today's stock market.
"The gencos are selling at 30 to 40 times earnings," noted Tirello, "but the utilities are selling at only 12 times. So utilities have been dropping their generation into unregulated subsidiaries, then spinning it off. That's how they get their money out of their merger deals-to get around the fact that the regulators often force the savings in mergers to go to the ratepayers."
And why are these stand-alone gencos selling at a premium? Tirello sees electricity demand skyrocketing in the next few years-forcing up prices and threatening shortages-and putting power producers into the catbird's seat. As a consequence, utilities that divested their power plants will become nonplayers.
"It's not getting better," he says. "It's getting worse."
Tirello continues. "I don't see prices coming down. You're going to have tremendous price swings in every region and the discos [the wires-only local distributor] can't do anything about it."
Remember Commonwealth Edison and its notorious fleet of nuclear plants, once the subject of a scathing report on the TV show, "60 Minutes"? Tirello now likes those plants. "They're getting more efficient," he says, "Why did the PUCs force them to sell?"
On that point, Illinois regulator Ruth Kretschmer answers, "Utilities sometimes want to do stupid things."
According to Kretschmer, Commonwealth Edison wanted to divest its generation when it came to the state utility commission.
"Com Ed wanted to freeze rates. They agreed to do it [divest] to get their way on legislation. But now," adds Kretschmer, with the price spikes of early summer running up purchased power costs, and with no flexibility to boost prices at retail, "Com Ed has been eating millions a day."
IS THERE ANOTHER WAY? Electric utility Detroit Edison and its parent company, DTE Energy, have proposed a different model. In early May they filed plans with the FERC to divest some 6,000-plus miles of regulated, utility-owned transmission lines (120-345 kilovolts) to a new stand-alone subsidiary to be named the International Transmission Co., which would operate initially as a subsidiary of DTE. In other words, Detroit Edison would make "a complete exit from the transmission business."
Edison and DTE fixed the net book value of transmission at $440 million. They said Edison would transfer the grid assets to ITC in a tax-free exchange for stock under Internal Revenue Code sec. 351. Edison would then transfer its ITC shares to DTE.
Of course, this proposal could be seen simply as a required first step for Detroit Edison to cement its membership within the proposed Alliance RTO, a group that includes American Electric Power, Consumers Energy, FirstEnergy, and Virginia Electric & Power Co. But the partners still have not found a way to win approval from the FERC, as the commission again ruled on May 17 that the Alliance transco would fail to satisfy the test for "independence" under the latest proposal, which would have had each of five member utilities owning a 5 percent equity share in the new Alliance stand-alone transmission company.
This move by Detroit Edison appears to be more than just a prequel to an Alliance RTO. In its application, filed by private counsel Clifford Sikora and Michael Sweeney Jr. of Truman Sanders LP, Edison says the transfer deal could serve as a springboard for any number of deals, including "one or more public or private offerings." It sees the deal as beneficial to Michigan consumers, since the state is a "classic load pocket," which suffers from "limited" grid links with utilities located in neighboring jurisdictions. By divesting transmission, says Edison, Michigan consumers should draw benefits as the ITC enjoys a greater incentive to invest in and expand the transmission grid.
And, as Edison says, the utility would be a hybrid, operating "solely as a generation and distribution company."
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