The New, New Thing?


At a posh dinner event and conference, industry experts speculate on the issues that could affect the industry in 2005.

Fortnightly Magazine - December 2004

It was the most exclusive, and one might say, one of the most extraordinary dinners. Never have I seen so many prominent CEOs, regulators, and financial gurus all in one room.

Hosted by a top Wall Street investment bank during the Edison Electric Institute (EEI) annual finance conference a few weeks ago, the event was held at San Diego's Museum of Contemporary Art. The museum, situated on top of the high hills of La Jolla and offering a breathtaking view of the ocean, was an unlikely place to discuss the future of the electric industry. But it was understandable, given events earlier that day. EEI had kicked off its finance conference with a number of panels that discussed the future of regulation, the future of power-plant development, and financing.

So there I was at "the dinner" in La Jolla, walking toward my numbered table, wondering what famous person in the industry I might be seated next to. I was not disappointed. At my table was a legendary billionaire financier, a prominent Midwest utility CEO, a top Washington policy guru, a large-cap utility finance executive, and an extremely well-respected energy investment banker.

After exchanging pleasantries, our discussion settled on the Fortnightly and some of the debates and issues that have been prominent within the journal's pages, particularly in the October 2004 issue. As you'll recall, the central issue in that edition was whether growth would be enough to satisfy shareholders in a back-to-basics model.

The Midwest CEO felt the pace of demand for power in his service territory and his corporate earnings would be enough to satisfy shareholders. The other utility executive agreed. But the investment banker politely pointed out that fixed-income securities could outperform utilities as investments (and draw away investors) if interest rates rise. In late November, this became a more pressing concern in the industry when the Federal Reserve raised the benchmark interest rate a quarter percentage point.

The next topic of discussion at the table was the future shape of the industry. The Washington policy guru believed that FERC's market-power test could be one of the biggest issues to define the industry in the coming months. The problem, he said, is that many utilities are planning to build more generation, and then drop it into rate base. But the more generation they drop into rate base, the more market power they will have and the greater likelihood that they will lose market-based rate authority.

While others at the table thought environmental issues and growth issues were shaping the industry, no one thought a "killer application"-like some type of renewable technology-would change the current paradigm of the industry. The promise of a future "hydrogen economy," in their estimation, continues to be decades away, even when environmental considerations are factored in. ยป

The Duty to Serve: A Double-Edged Sword

At the end of the evening, the Midwest CEO launched into a lengthy talk about the "duty to serve" and how he believed he was doing a noble thing and giving back to society.

This bit of nostalgia was striking-incontrovertible proof that utility leaders are looking to the past as a model of the future in a way that may be surprising. Back-to-basics was a mantra of returning the industry to its roots, to their core business of delivering and generating power. But not a return to the regulatory compact. The regulatory environment is not what it was 40 years ago. Furthermore, others say renewing the regulatory compact of years ago may not be in the industry's best interests.

At a Merrill Lynch conference a few months ago, another Midwest CEO, Michael Morris of American Electric Power, said, "It's time to reconstruct the regulatory compact. I know how old-fashioned that sounds. ... We have a joint obligation and a duty to continue to serve our customers. We need to reestablish the notion that this is a business we are in together. There was a time when we [utilities and regulators] really did work together."

As the financier at my table at the EEI finance conference pointed out, one should remember the quid pro quo involved in that compact.

Experts I discussed this issue with said that if utilities are seriously contemplating the regulatory compact, they must not remember that the compact means earning less. One told me, "Sure, some utilities may be able to go back to the regulatory compact and have their monopoly territories back again, but in exchange for that monopoly or service territory, and to ensure they get on the golf course by 3 p.m. every day, they'll have to accept less earnings."

That's what makes Morris' comments so startling-they don't seem to mesh with his efforts to make AEP part of the PJM RTO so he can sell his cheap coal megawatts for top dollar in the Northeast. His statement may have been designed as an effort to protect his service territory from other suppliers, but you can't have it both ways, many say. If you want to earn top dollar in other markets, you have to be willing to risk someone earning top dollar in your market. That's what competitive markets are all about. Furthermore, most finance experts say that if the industry were to truly return to cost-based rates, the only entity wanting to buy utility stock would be the utilities.