Frontlines

Deck: 
Energy companies' best-laid plans in 2001 were put on hold, after circumstance and fate stepped in.
Fortnightly Magazine - December 2001

Frontlines

The Year of Living Dangerously

Energy companies' best-laid plans in 2001 were put on hold, after circumstance and fate stepped in.

The year 2001 will not be remembered as a very good year in our industry. Energy chieftains who had positioned their companies to reap the rewards of merchant generation, energy trading, global power privatization, US energy restructuring and a stock market environment that had rewarded the bold risk-takers in the beginning of the year, found by the end of the year that the risks were not being outweighed by the rewards.

In fact, every significant utility and energy company strategy suffered some sort of setback. Those pursuing a retail competition strategy watched as the California Crisis precipitated a decline in interest by states in retail competition. Also, after the California Crisis, merchant generators were no longer estimated to reap the same windfall profits, and distributed generation companies no longer had rolling blackouts to point to as a reason to buy their product. In fact, the decline in the economy, combined with continuous merchant plant development, had Wall Street investors devalue the merchant sector's earnings estimates in September. It seems that fortune did not reward the risk takers, but the conservative, stable players, which kept their non-regulated businesses under the same umbrella with their regulated businesses.

In fact, it was low-risk, stable earning companies like KeySpan that were rewarded this year at the Edison Electric Institute Finance Conference for long-term financial achievement. The company received the EEI Index Award for having achieved 265 percent total return over the five-year period 1996-2000, exceeding the S&P return of 114 percent for the same period. In previous years, EEI had awarded its coveted prize to companies that had diversified and pursued aggressive non-regulated activities such as generation and telecommunications.

Not this time. KeySpan is a large distributor of natural gas in the Northeast, and the largest investor-owned electric generator in New York State.

Maybe it is no coincidence that several companies announced dramatic shifts in their corporate plans following the conference itself, shifts back to an integrated utility structure.

In fact, UtiliCorp United's CEO Richard C. Green, Jr. decided to bring his company's power marketing and trading company back into the fold by reacquiring all the shares of the partly spun-off company. This was less than a year after the company had spun off its Aquila subsidiary. What happened?

"The recent significant changes in the merchant energy sector, the general economy and the impact of these changes on the capital markets were definitely factors in the board's decision,'' said Green.

Of course, Green was not the only one this year to reposition his company. In a surprise announcement, Constellation Energy Group announced that it had chosen to remain a single company with two major lines of business, thereby canceling its previously announced plans to separate its merchant energy business from its retail business, which includes Baltimore Gas & Electric.

Even more of a surprise, Constellation and Goldman, Sachs terminated its power advisory relationship. I still remember being given a tour of Constellation's swank, hard-wood trading floors a few years ago, and listening to how the agreement between the two would lead to them becoming the premier energy trader in North America. I also remember both Constellation and Goldman, Sachs employees touting the risk management systems and advanced capabilities they would have to beat their competition. At the time, it seemed like a marriage made in heaven.

Instead, the companies are separating-at a price. Constellation is "paying" $355 million to Goldman, Sachs to terminate the relationship.

The company explained that the cost of raising the spin-off's equity would not cover its future income.

"A year ago we thought the sum of parts looked greater than the whole and now after what's happened in the world (since then) we don't see that. There is no great advantage in being separate. What seems to matter now is size and stability and we think that comes from being a single company,'' said Constellation's Chairman and CEO Christian Poindexter.

Poindexter, like his counterpart at UtiliCorp, is, of course, right. The markets have changed, not only here, but also abroad.

Another high profile company to do an about-face in the last month was CMS Energy. No longer would it pin its earnings hopes on an international strategy. The debt burden had become too large, overseas markets were not bringing in the cash, so it was time to sell, sell, sell ... and focus on the U.S.

Where will the earnings come from? Seven percent to 9 percent will be achieved with growth principally in electric and gas marketing, exploration and production, pipelines, midstream and liquefied natural gas receiving and processing, according to a CMS quarterly earnings report.

The New Defense Posture: Green Light From Wall Street?

So, how has the industry retrenching gone down with investors?

CMS Energy was upgraded by CIBC World Markets. But Merrill Lynch downgraded Aquila, UtiliCorp's energy trading & marketing division.

"We see near-term issues holding the stock back after strategic U-turn on [the] Aquila spin-off," said Merrill Lynch analyst Steven Fleishman. Issues expected to hold UtiliCorp stock back "include 1) arbitrage pressure while the exchange is outstanding; 2) dilution potential if the exchange has to be increased; 3) reversion to UtiliCorp's former conglomerate discount valuation; and 4) risks of market dislocation if and when the offer is completed."

Banc of America Securities downgraded Constellation. According to a Standard & Poors Stock Report, which also downgraded the company, "Having been badly hurt by CEG's earlier announcement of an expected earnings shortfall for 2001, the shares dropped again after the company announced that it had cancelled the pending separation of its merchant energy operations and that it expected its earnings for 2002 to be relatively flat with those of 2001.

"Given this outlook, we expect investors to avoid these shares for the near term. However, with the stock down nearly 60 percent from its year to date high, and trading at about eight times our new 2002 estimate, we would recommend accumulation for those investors with a longer time horizon," according to the S&P report. It appears Wall Street isn't being all that forgiving, even as the holidays approach.

But the Street is offering advice.

S&P predicts survivors in 2002 are likely to be utilities that pay down debt, lower dividend payouts, pursue customers outside their service area, and add new, unregulated products and services. It doesn't seem to sound all that different from last year's advice. Perhaps that's part of a universal problem. Those who take the risks or blaze a new path seldom know where it will lead, nor do their advisors.

Wishing you a great holiday.

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