The Ultimate CEOs: Lewis Hay III, FPL Group


The CEO Power Forum: Not all utility CEOs are created equal...

Fortnightly Magazine - June 2005

Lewis Hay III

Chairman, President and CEO, FPL Group

"I think fuel mix is a question that every CEO of a utility in America is struggling with right now. There are not a lot of good alternatives for us."

Public Utilities Fortnightly How would you characterize the wind business? Why is this business attractive to FPL and how does it compare to other utility businesses?

Lewis Hay III This is an area where there is still a tremendous amount of demand and therefore growth. We haven't seen in the last few years too much demand for generation because of the over-building that occurred in the late 1990s and the early 2000 period of time. But even though there hasn't been demand for traditional generation, with more than 16 states having passed renewable portfolio standards, we're seeing a lot of demand for renewable energy. We believe wind energy is far and away the most economic of the alternatives.

Fortnightly Wind accounts for about eight percent of FPL Group's generation mix. What would be your goal in terms of expansion? What sort of growth potential does it have in the next few years?

Hay We're forecasting this year that we'll add between 500 MW and 750 MW. By its very nature with the production tax credits sort of coming and going, depending on what happens with Congress, wind has been a little choppy in terms of year-by-year growth. But we have been averaging right around 500 MW per year for the last five or six years or so. I see no reason to believe that we can't continue that pace for a number of years to come.

Fortnightly How does wind contribute to FPL Group's bottom line? If I were an investor, how would you explain the value proposition?

Hay We've been earning returns that are well in excess of what our regulated utility makes in our wind business.

Fortnightly Even as more renewables are developed, the contribution in percentage terms nationally is still very low as compared to fossil fuels. How do you believe renewables will make a more meaningful contribution to the nation's resource mix? What needs to happen?

Hay As I mentioned earlier, a number of states have passed renewable portfolio standards (RPS). We believe that is appropriately done at the state level. I'm not sure that it makes sense for all states to pass an RPS. But even without an RPS, we're seeing, particularly for wind again, with natural gas prices in the $7.00 plus range, wind is very economic even without a state passing an RPS. Quite a few of our customers who bought wind power over the last few years are delighted at the prices that they are paying for wind energy.

I think, as fuel prices stay high, you are going to see a lot more demand for renewables. ... The president was pushing Clear Skies a few months ago. That didn't pass yet, but I think it is inevitable that we will have new environmental laws passed. I think that will be a positive for renewables. ... There's a lot of reasons to be bullish on the renewables front.

Fortnightly There is much discussion among energy technology specialists over when solar will become economic. FPL Group purchased some significant solar assets in California recently. Can you tell us of the economics of solar currently and where you feel it is headed?

Hay First of all, there are different forms of solar. ... Photovoltaics are still very, very expensive and will only apply to niche-type situations. The technology we employ is, simply put, very large mirrors that focus the sun's rays on to a thermal collector. Basically, we heat a fluid that then goes through a heat exchanger and makes steam, and from there on it's the conventional way of generating electricity by running steam through a turbine generator set. The economics for new solar, even though that type of solar is more economical than photovoltaics, I would say it is a fairly expensive technology. One of the advantages of solar is that it really operates as a peaker. For instance, our plants are in the Mohave desert. They produce power from roughly 8 o'clock in the morning to 7 or 8 o'clock at night. That is usually when demand is the highest. It is, frankly, far more reliable than the wind energy. Again, it's intermittent in that you don't get any power at night, but relative to peakers the economics are not that bad.

Fortnightly What kind of returns do you think you can get from a solar array?

Hay Well, keep in mind that the ones that we just bought were existing operations. They are adjacent to the ones we were already operating. So, we believe there were a lot of operational synergies associated with those. I think it is fair to say we are not paying replacement prices for the assets that we are buying. So, I think the returns are going to be very attractive... They are double digit returns for sure. But remember that is buying an existing asset at a discount to its replacement price. If you created a brand new facility using the same technology, I'm not sure the returns would ever be satisfactory.

Fortnightly How do you think greater consolidation will affect FPL Group? Are you concerned that such consolidation will affect the competitiveness of energy markets in which FPL Group participates?

Hay First of all, I hear a lot of talk about accelerated consolidation. I am a big believer that this industry will ultimately consolidate. But I am a little skeptical that just because of the Exelon-PSEG merger, that it is going to rapidly consolidate. In fact, the administrative law judge the other day for the SEC's ruling on AEP's merger with CSW five years ago is going to cause a lot of people to at least pause and think before they go forward with the merger until that whole thing gets sorted out.

That answers one part of your question. The second part is competitive markets. We do participate in a number of competitive markets. As you know, Florida Power & Light is in a regulated market. I think the jury is still out on the benefits of competitive markets. We haven't seen significantly lower prices in competitive markets than in regulated markets. In fact, I could argue that you have seen the exact opposite in many cases. It seems that customers are still questioning the benefits of competitive markets.

I saw an article a few weeks ago where large industrial customers were complaining about the costs they were incurring essentially caused from increased costs caused by regional transmission organizations. It's hard for me to say where the market is going. I think the genie is out of the bottle, so to speak. I don't think the markets that have gone competitive are going to reverse course. But I don't see a lot of compelling data for the markets that are currently regulated to deregulate. So, it's not clear to me that even if we have more consolidation that's going to change that dynamic or balance between competitive and regulated markets.

Fortnightly According to press materials, in late March, FPL Group announced the purchase of a Texas retail group called GEXA as an entry to retail competitive markets in Texas. What's the value proposition?

Hay I really can't comment too much on GEXA because we are in a quiet period. The objective of us entering competitive markets was frankly to learn more about the competitive business in the event Florida ever deregulated that we would be down the learning curve in terms of knowing how to compete under a different set of rules. But we also felt that we were a good operator of power plants and that the wholesale generation business in particular is a commodity business, and to be successful in commodity businesses you have to be a good operator. In fact, you have to be a low-cost operator. Based on a lot of benchmarking data that we did, we feel that we qualify. We felt we had the skill base necessary to compete, and so far we think that strategy is proving out.

Fortnightly In the face of high gas prices and tougher proposed environmental rules, what is the ideal fuel mix to meet future electricity demand?

Hay I think fuel mix is a question that every CEO of a utility in America is struggling with right now. There are not a lot of good alternatives for us. As you mention, natural gas is becoming scarcer. The prices are much higher than they were a few years ago, and most people are expecting them to stay high. Coal comes with very high capital costs, and at least at the moment a very uncertain regulatory future when it comes to environmental regulations. So, it's not the most attractive alternative.

I think a lot of us would like to see new nuclear plants built, but there is still too much regulatory uncertainty there. Nobody wants to have the same problems that the last wave of nuclear plants went through, where they never were built or partially built. Because of anti-nuclear interests, construction was halted, or the plants never got to run and then the capital costs kept compounding. A plant that should have been $1 [billion] or $2 billion ended up costing between $5 [billion] and $7 billion. No CEO wants their shareholders to have to suffer through that again. So there are not a lot of good alternatives at this point.

Fortnightly Which is the lesser evil as far as fuel mix? Which of the limited options do you choose from?

Hay We have a natural-gas plant at out Turkey Point site that is under construction. I'd have to say that is still something that we favor because it is something that we know. But what I'm trying to do is improve our fuel diversity in our mix. Even though there is some uncertainty associated with coal, we have filed with the public service commission plans to build some clean coal plants going forward. I think the key is to keep a balanced portfolio so if any one fuel becomes disfavored for one reason or another, you have other fuels to offset that.

Fortnightly Are you hopeful that LNG will lower natural gas prices through more supply? When do you hope to have your LNG project online?

Hay Yes I do. I am very hopeful about LNG. We have an LNG project that we are working on with several partners that would definitely involve a re-gasifier in the Bahamas and then a pipeline underwater that would connect with the existing natural gas pipeline infrastructure in South Florida. But we have had one regulatory hoop after another to jump through, and the projects turned out to be much more difficult than I think anyone envisioned.

To the extent that we can bring liquefied natural gas into Florida, that would improve the reliability of gas supply into Florida [and] help the supply-demand balance. ... Since we don't have all our permits at this point, there is no timeline. But we are shooting for the 2009, 2010 timeframe.

Fortnightly Private equity groups have in the last few years purchased an unprecedented number of generation power plants (see "Business & Money"). How do you view this new subset or this new constituency in the energy industry?

Hay I have mixed views about it. Given some of the prices that have been paid, they must have a lower cost of capital than companies such as ours. But I don't know that for a fact. Obviously, it creates more competition for assets, and since part of our strategy is to grow our portfolio through asset acquisition, at the end of the day it creates more competition. I guess I would prefer, all things being equal, not to have that extra competition, but that's the nature of the business we're in. If it weren't private equity it would be somebody else bidding on the plants.