Quixotic Commission?

Fortnightly Magazine - June 2008

When Spanish utility giant Iberdrola announced last June that it would acquire Maine-based Energy East for $4.5 billion, it signaled a potential surge in major foreign owners buying into U.S. utility companies.

The deal seemed to be moving smoothly, garnering approvals from Energy East shareholders as well as federal and state regulators. But then the staff of the New York Public Service Commission (PSC) indicated they might require more from Iberdrola before approving the acquisition. The main sticking point: The potential for Iberdrola to dominate the windpower industry in New York.

Specifically the PSC staff said Iberdrola would need to divest its 50 percent interest in the Maple Ridge wind farm, New York’s largest, with 195 turbines totaling 320 MW of windpower capacity.

A global leader in windpower development, Iberdrola hopes to build at least 10 new wind farms in the state. Iberdrola agreed to sell Energy East’s fossil-fueled power plants in New York to appease the commission’s market-power concerns, but the company is standing firm on its windpower position.

Fortnightly spoke with Pedro Azagra, director of corporate development for Iberdrola S.A. in Bilbao, Spain, to get an update on the acquisition, and his impression of U.S. merger-approval processes.

Fortnightly: What’s the status of your plans to acquire Energy East?

Azagra: The only thing pending is the New York PSC’s approval. An administrative law judge is expected to issue his recommendation to the PSC by early June, and then the commissioners make their decision.

The only party that has a position we strongly disagree with is the staff of the New York PSC. The other parties are willing to make a deal.

Fortnightly: New York seems to be saying they have an unbundled power market, and they won’t allow Iberdrola to control both generation markets and retail distribution. How will Iberdrola overcome that position?

Azagra: It’s easy for regulators to say we have this policy and we’re going to comply with it. But in fact that policy shouldn’t affect our deal.

Three items are most important for our deal. First is protecting consumers from financial risk. Staff will argue that we need to protect the ratepayers and quality of service at Energy East, and make sure it doesn’t become a more risky company when changing hands. A few simple hints will tell you how much better off the company will be with us than without us. We have credit ratings one, two and three notches higher than Energy East. And if you look to our capacity to pay our bills—our interest ratios— you’ll see that Iberdrola has two to three times better ratios. Those two numbers give you a simple way to understand how much better financially protected the company is going to be.

Also we’ve raised cash to pay for this acquisition. There will be no debt at all in this buyout, compared to other deals.

The second item is vertical market power. Energy East owns certain generation assets and they haven’t been forced to sell them. So how can someone who buys shares in that company have any more market power than Energy East does?

Iberdrola has strong plans for windpower in New York, but wind technology is not a market-power technology. Market-power technologies are those that are capable of fixing prices. Wind doesn’t blow when you want it to, plus it isn’t economically efficient. You need tax credits or other mechanisms to make it viable. It’s not a market-power technology if it’s either subsidized or a price taker. It would be the first time in the world that a regulator is treating wind as a market power technology.

Some might argue the problem isn’t really market power in terms of prices, but Iberdrola’s affiliation with the subsidiary that owns the capacity. The subsidiary could call the utilities and say when you’re talking to Iberdrola Renewables make sure the connection gets done faster. But that’s not a market- power issue, but a code-of-conduct issue. The New York ISO has rules for connecting power plants and the public process involved. If you have any doubts about how we’ll behave, you’re saying we won’t obey the law. I have no problem with any enhanced code of conduct, but don’t tell me it’s a market-power issue.

The third category is what the PSC calls the benefits of the transaction. We are offering $200 million in benefits for consumers, $50 million up front in day-one rate reductions. Looking to the last 10 years of comparable transactions, the range of such benefits is from $40 million to $160 million. We wanted to make customers happy, so that’s why we went to the upper end of the range.

Some people in New York might say we don’t need Iberdrola, but New York needs investment. We are the number-one renewable company in the world, and we want to invest a lot in the state. If we send a message that we are out of New York, that’s a bad thing for a lot of people. Turn it around. New York wants to add 7,000 MW of renewable projects. How much of that is real? Can it be built in three to five years as hoped? How many of the people sponsoring projects have turbines? Iberdrola has 1,000 MW of turbines each year for the next five years. We would love to put as much as possible into New York. Ask other people how many turbines they have to put into operation. You’d be shocked.

Fortnightly: What does the Energy East acquisition have to do with Iberdrola Renewables’ investment plans for New York?

Azagra: When going into the United States, we need to focus from a geographical point of view. We can’t do a utilities business in Oregon, wind in New York and gas in Michigan. We like to focus, and we take an integrated position, with supply, T&D and gas storage. Our commitment is to focus in the region. To just do wind in New York doesn’t make sense for us. But New York and New England, as a utility and wind development, it’s the right opportunity.

Fortnightly: I hear talk about Iberdrola being courted by EdF, and about Iberdrola trying to buy British Energy. How does an investment in Energy East figure into Iberdrola’s global business position?

Azagra: We want EE to become the heart of Iberdrola in the United States. It’s small but we will use it for a platform to make big investments. Once we complete the acquisition, the next item is how many billion dollars can we invest?

Fortnightly: What’s your perspective on the U.S. market at this point? What do you think of the way we review and regulate utility mergers?

Azagra: We’re the second largest wind operator today in the United States, and the third largest gas-storage company. We’re very happy with the U.S. market. But the regulatory process is very strange. You can close a $20 billion deal in Europe in three months, but a $4 billion deal in the United States takes a year or more. That’s strange, and something is wrong with one of them. You can guess which one I think.

Regarding regulation and market power policies, you should ask the PSC staff to explain the success of market power policies in New York. After several years of unbundling the state has the third highest market prices in the United States. Why? That’s the question we should be asking.

Fortnightly: If market power isn’t an issue, why do you think the commission has taken its position?

Azagra: If you review the staff’s approach to the last 10 years of deals, you’ll find the answer. They are doing their job as they understand it, and they are trying to put the deal through this approach. But we don’t think we should be making statements on the assumption we are negotiating. When I want $100, I say $100.

We take the regulatory process seriously. But in New York when they want to reach $100, they say $400. When you go through the numbers and requests, people have an issue explaining where the numbers come from.

Fortnightly: Are you saying New York is negotiating to get a bigger payoff?

Azagra: That is what a lot of people would tell you. That’s why only one party would take such an extreme position.

Sometimes these deals are problematic. We have many parties in favor of it, which gives us comfort that we are doing the right things. Maine has a track record of being tough, but we reached a settlement without even $1 being considered. They’ve given a lot of importance to Iberdrola taking over Central Maine Power, and what it means for such a big company to be making such an investment in the state.

We have a lot of companies calling us, asking to do business. We’re not asking to be treated favorably, but just the same as others. Approve the deal in accordance with how you’ve approved deals before, and let me invest.