Casino Royale?


Utilities place billion-dollar bets on infrastructure, but the deck may be stacked against them.

Fortnightly Magazine - December 2006

Something seems deeply disturbing about the utility industry these days. An almost palpable tension rises whenever the utility CEO is asked how he will build enough power plants to meet the skyrocketing demand for power. Some consultants predict that sometime after this decade the time will come when utilities won’t be able to build enough to meet demand, no matter what they try.

The companies, of course, won’t tell you directly they can’t build enough plants. Such an admission would not go over well with politicians, regulators, investors, and the general public.

But they will tell you indirectly what the odds are, in subtle fashion, by talking about the siting issues, financing difficulties, the technology challenges, personnel shortages, and the billions in needed capital that their balance sheets can’t manage.

Industry veterans may have heard this all before, but at this year’s EEI Finance conference—in Las Vegas, aptly—attendees discussed and debated newly proposed utility business plans.

“I give you 10-to-1 odds,” said one, “that TXU CEO John Wilder brings his coal plants in on time and under budget.” That comment referred to TXU’s Nov. 6 announcement that the utility could miss its target of completing the first of nine planned new coal-fired power plants in Texas by the summer of 2009, due to delays in securing permits required to start construction.

“Oh yeah? I give you 3-to-2,” said another, “that Duke Energy CEO James Rogers doesn’t live long enough to see his nuclear plant get built.” The speaker was skeptical over the so-called nuclear renaissance, and also mindful of Duke’s recent upward revision on its proposed nuclear power-plant costs, which now are projected to exceed $2 billion. (On Oct. 20, the North Carolina attorney general challenged Duke Energy to raise customer rates there to help pay for nuclear plants yet to be built.)

I overheard such playful banter many times among conference attendees. And I did see Duke’s Rogers at the Merrill Lynch CEO dinner. He looked to be in good health and was optimistic on the regulatory front, so I’d give odds that rumors of his demise are quite a bit exaggerated, though he does face significant challenges in providing for rate recovery of all those construction costs.

EES North America

They say that what happens in Vegas stays in Vegas. That may serve well for the casino, but not for the conference proper. With neon lights blazing on the Strip, the utility executives competed to dazzle investors, analysts, bankers, and the rest of us with their plans for construction, corporate spinoffs, and joint ventures.

It would be a shame not to share with you details on the deals that drew the most buzz.

Deal Number 1

The Players. American Electric Power, Mid-American Holdings

The Project. AEP announces a 50-50 joint venture (JV) with MidAmerican to build new transmission assets in Texas. AEP will contribute about $100 million of Texas transmission assets under construction. A subsidiary of MidAmerican Energy Holdings, owned by Berkshire Hathaway Inc. and other investors, would contribute cash. The companies said up to $1 billion of projects could be included in the new JV over the next several years.

The Buzz. Many utility CEOs are concerned that they will not be able to raise enough capital to meet their infrastructure-development demands. A partnership with a deep-pocketed investor like Warren Buffett is seen as a shrewd move, but given that Buffett might have been doing some branding recently in keynoting the National Association of Regulatory Utility Commissioners annual conference in November, his company, MidAmerican, may be using the JV to position for a major utility acquisition. Watch out, AEP!

Deal Number 2

The Players. Duke Energy, Spectra Energy Corp.

The Project. Duke is to spin off its natural-gas business, which will be named Spectra Energy Corp., by Jan. 1, 2007. When the separation is complete, Spectra will consist of Duke Energy Gas Transmission and Duke’s 50 percent stake in Duke Energy Field Services. The new company will operate in three main sectors of the natural-gas industry: transmission and storage, distribution, and processing.

The Buzz. Some debate remains in the industry as to whether the “pure-play” model is best. In fact, a debate continues to rage over the ideal business model. Some say Duke’s favorable reaction from Wall Street on its gas spin-off announcement contributed to Dominion’s plan to exit from its exploration and production business. At the EEI Finance conference, Dominion CEO Tom Farrell showed clearly how his company’s E&P business was not being viewed as highly as other E&Ps in the sector. Utility executives have called such a move a “paring down” of the business to be more transparent to investors. But as interest rates rise, the question many utilities executives asked was whether pure electric utility growth is still enough for investors.

Deal Number 3—Not

At the conference, TXU’s John Wilder said he had thought about spinning off his company’s transmission assets at one time (as many infrastructure and pension funds are advocating). However, he admitted that doing so would be impossible because TXU would lose the credit metrics and balance sheet to shoulder the needed power-plant buildout. In fact, Wilder reiterated many times that today’s utilities are simply not large enough by market capitalization requirements to undertake the size of the buildouts they are pursuing.

To paraphrase Wilder, a $6 billion market capitalization company attempting to undertake a $6 billion buildout simply is not ideal, particularly if you compare these with the cost of infrastructure buildouts in other industries.

Out of the Money?

Could the industry’s business model be broken? This provocative idea was discussed and debated at Accenture’s International Utilities and Energy Conference in late October, in Boca Raton, Fla.

The moderator of the “Utility Transformation” panel reminded us of recent failures in the U.S. airline and automobile manufacturing businesses. But panelists such as Phillip G. Harris, president and CEO, PJM Interconnection LLC, believe a company’s survival depends on its understanding of the source of its value, or core competency.

Harris recalled the early beginnings of the famed DuPont Co. DuPont, which started as a gun powder mill, would never have become the renowned chemicals company if the DuPonts hadn’t figured out that chemistry, not black powder, was its core competency. Harris says PJM’s core competency is really “data-to-information.”

Unfortunately, the information from the three other panelists didn’t offer a clear-cut answer for the source of utility value. A KeySpan executive believed his core competency was utility services. A PG&E Corp. executive believed value came from having integrity. The former Cinergy executive thought his company’s core competency was building and maintaining relationships.

Three of a different kind usually doesn’t do well at almost any card game. Utilities had better start playing a stronger hand in what is quickly becoming the final round.