PNM: Aggressive wholesale player eyes market south of the border

Public Service Company of New Mexico (PNM) heads into New Mexico’s restructuring with optimism. It’s counting on its success in power generation, wholesale power marketing and energy service business to provide growth in the years to come.

PNM operates a combined electric and gas utility serving about 1.3 million people in New Mexico. Its 1,506 MW of generation capacity includes power from coal, nuclear and natural gas-fired plants. Wholesale power sales, accounting for nearly a third of its 1999 total operating revenues, is the fastest-growing part of their business.

EL&P spoke with Jeff Sterba, PNM’s CEO, in July about the company’s direction.

EL&P: What lead to the recent creation of the holding company, Manzano Corp.?

Sterba: The holding company completion, which has been approved by shareholders, is still waiting regulatory approval through the adoption of our separation plan. What really drove the creation of the holding company was the passage of the New Mexico restructuring act in 1999, which paves the way for customer choice and the restructuring of the industry in New Mexico and requires that regulated and unregulated operations be separated. It does not require divestiture of generation, but it does require that generation resources must be placed in a separate affiliate under a holding company with the utility being a subsidiary of that holding company also. In this instance, it really was the legislation that mandates it but the fundamental business reasons that support its creation really are two-fold. One is our belief that we want to remain in both regulated and unregulated operations. Two, the appropriate structure for governance and for regulatory purposes is the creation of a holding company such that the regulators can look very hard and clear at the regulated box and then at transactions that occur between that regulated box and other affiliates or the parent. PNM has tried on two other occasions that I recall to create a holding company and has not been able to get it through the regulatory approval process going back to the 1980s. In some senses, the inability to put in place a holding company in the past has hampered our ability to expand our unregulated operations as aggressively as we otherwise might have.

EL&P: There is considerable merchant generation development in Arizona; do you anticipate similar development in New Mexico?

Sterba: I do. What drives generation development is the opportunity to put new generation in places where it is required. The western United States operates differently than the more densely populated eastern United States in that there are clear marketing hubs that have developed where the bulk of transactions take place. Palo Verde, Four Corners, the Las Vegas area and the California-Oregon-Border are probably the four most prominent marketing hubs. Consequently, when you can locate generation near those marketing hubs, you not only have the ability to try to sell into the local market, but you have the ability to interconnect with a much broader based market because of the transmission interconnections that have developed at those hubs. I also expect to see generation development in the state because there are load pockets that are transmission constrained and that provide a need for additional generation. Duke announced a 650 MW generation facility in the southern part of New Mexico. A 150 MW facility has been announced just south of Albuquerque, and there are probably three or four others in the 200 MW class that are in various stages of planning. Increasingly in the West, one of the issues [affecting new generation] is the issue of water. It created a stumbling block for generation in the Phoenix area and has also created a stumbling block for a project located down near Belinda, Mexico. The availability of water or the willingness of a community to give up water resources for a steam generation facility is a tough issue for communities in the West where water is truly becoming one of the limiters of growth.

EL&P: There was another newly announced gas-fired generating plant near Albuquerque, the Delta-Persons Station.

Sterba: That is a project we’ve been involved in. It is the first major project in which we are the purchaser of all the power but we did not build it. We helped develop it, but we don’t own it. It was just placed into commercial operation a couple of weeks ago and it’s going to be a valuable resource to help ensure reliability of supply in the Albuquerque area plus also provide a peaking resource that can be marketed.

EL&P: What is the operating reserve capacity in your service territory?

Sterba: With the addition of the peaking facility at Persons Station, we’re just slightly above 20 percent, about 22 to23 percent for this year. With our load growth, that will decline to about 15 percent within about two or three years. New Mexico is reasonably well-situated; our biggest problem has been that most of our resources are located distant from the load areas and transmission expansion within this state has been problematic. The last major transmission addition to the system was in 1984, 16 years ago. Load has grown quite significantly since then. We’ve got an adequate level of operating reserves within the New Mexico region today, but it doesn’t take much load growth to diminish that significantly.More importantly, you have to look to the broader marketplace because as we move into the future, the resources PNM has today will not be dedicated to serve New Mexico resources. With the restructuring act, under which customers will gain access in 2002, none of the generation that we have will be dedicated to serve the existing retail loads. The delivery company, which will retain the name PNM, will be set up to be a neutral facilitator of transactions between its customers and competitive service providers, which may include the competitive service affiliate. It will have an obligation to provide standard offer service to residential and small commercial customers but that will be procured competitively and the resources we have today will not be committed to serve those customers. We have seen increasing concerns about the availability of generation within the western marketplace, which has driven market prices up quite significantly this year. I think that’s really temporal, and if we look at the number of projects that are announced and planned to be brought on line in the WSCC [Western Systems Coordinating Council] or even in the Southwest and southern California region, it is a substantial number of megawatts, something in excess of 20,000 within the next five years.

EL&P: What is your estimated load growth over the next few years?

Sterba: New Mexico has been one of these interesting economies that has done well in growth through virtually all economic cycles. We’ve been growing about three-and-a-half percent per year over the last five, six years. We are seeing in the near term a slowdown as this economy continues to make a shift from a defense and energy based economy into more of a technology economy. Major energy-intensive elements associated with Sandia Labs, Los Alamos National Laboratories and Kirtland Air Force Base have been part of that growth and now we see scale-back in the defense and energy related installations within New Mexico. While we’ve had strong industrial growth, particularly in the technology sector with Intel and Phillips and a number of other semiconductor and technology-related operations, it has slowed down in the last 18 months. Over the next couple of years, we’ll still be in the three percent range, but probably a little less than we’ve grown over the last five years. As we look a little further out, we’re starting to see some significant potential growth opportunities. Earlier this summer, an announcement was made about a new firm backed by Bill Gates that will manufacture a small corporate jet. They’re going to locate their manufacturing facility in Albuquerque. Plus we’ve had Intel announce a new expansion of their fabrication facility that will employ another 1,500 people by 2002. I think we’re going to go through a lull where our growth rates may drop into the two-and-a-half to three percent range, and then we’ll see it move back up into the three-and-a-half percent range.

EL&P: Given your recent agreement with ALSTOM to develop a transmission line into Mexico, what are your plans for supplying power to the Mexican market?

Sterba: Mexico is a marketplace that is in dire need of resources and physical support of their transmission grid. The election of Vicente Fox is a very positive sign for what will happen in the electricity sector for Mexico. They have gone through a process of saying that they want to restructure and place into competitive operation the electricity marketplace in Mexico, but they have had fundamental resistance to its implementation. The change in administration will not only continue the efforts that had been started by CFE [Comision Federal de Electricidad, the Mexican national utility] and the secretary of energy, but will accelerate them.Northern Mexico’s electrical requirements are growing at eight or nine percent, and they have no way to meet that growing load. Some of it is going to require significant capital investment in generation facilities located within Mexico. At the same time, technically and economically it cries out for some interconnections to be developed, which at this time would have to be asynchronous or block loading of load where it shifts to the northern grid. The difficulty is that you must have some form of contracts that can help support the development of those transmission interconnections. As we pursue this transmission project, we intend and anticipate that it will be an open access facility. It will clearly be able to pay for itself but it will also pave the way for having transactions that we and others would make across it. The changes that I hope to see happen in Mexico over the next 12 to 18 months will provide the opportunity for that project to take its next step forward.

EL&P: PNM filed its transition plan with state regulators on May 31, including its planned participation in Desert STAR (RTO). What changes do you anticipate in your transmission planning and operation with RTO involvement?

Sterba: Desert STAR has been in the works for quite some time. I’m disappointed with the progress, or the lack thereof, that Desert STAR is making in resolving some of the fundamental issues that have to be addressed. At the same time, it is an extremely complex undertaking and in the West we have a lot of different interests.We probably have a fair amount more public power involvement in the West—both transmission-owning public power entities as well as transmission-dependent public power entities. We have a fairly robust set of players that cover the whole gamut and it appears that Desert STAR is struggling to resolve some of the issues of operation and governance that are necessary for it to be able to go forward. We’re looking at other options if Desert STAR is unable to resolve the issues and is unable to operate the transmission organization at a reasonable cost with an utmost commitment to reliability and security of the grid. How is it going to change transmission planning and operation? It’s going to change it in almost every way one can think of. Some of it is not so much RTO driven as it’s just restructuring driven. For example, the whole notion of integrated resource planning of transmission and generation siting is something that is going to have a very different texture to it with generation being competitively driven and without, at this stage, good guidance about appropriate pricing of transmission and what’s going to be allowed by FERC in terms of appropriate transmission pricing. Utilities, the delivery companies, are really going to have to focus on the development of the security of supply for their own area. When we face a future in which transmission planning, pricing and utilization is completely decoupled—and appropriately so—from generation development, it creates a complexity, and until issues of transmission pricing—return on equity, etc.—are resolved appropriately by FERC, utilities are going to be very careful about taking the political risk of trying to develop transmission facilities.

EL&P: Does PNM anticipate any merger and acquisition activity in the near- or long-term?

Sterba: Well, you know the answer I have to give to that: We don’t comment on matters of that kind. Everyone’s looking at everybody, whether it’s defensively or offensively. The good thing that’s happening is that the mergers that you see today are starting to have more strategic direction to them; they’re not just ‘let’s get bigger so we’ve got more protection’ or ‘we better do this because everyone else is going to do it’ or ‘if we don’t do it, someone’s going to do it to us.’ They’re starting to fit more business strategy reasons and I think that’s healthy and good for the industry. From our perspective, first and foremost, our goal is to complete restructuring, implement customer choice as smoothly as possible, make sure that we are the best utility we can be serving our retail customers today and growing our unregulated operation, particularly focusing on our bulk power wholesale trading operation. When we look at people who may look at us—’are we an acquisition target?’—with the regulatory issues we still have on the table, it’s hard for me to see someone being very serious about looking at us until that regulatory uncertainty is resolved. The same is true about our ability and interest in looking at doing anything [about possible mergers and acquisitions].

EL&P: What are your plans for continuing to expand wholesale power sales and trading efforts?

Sterba: This is a business that we’ve been in for quite some time, not because we had a big strategic session, but because we were a utility in a situation of excess capacity starting in the mid-1980s. We had to become aggressive in the wholesale marketplace. We had to find ways to help turn this what at that time was a ‘good old boy’ wholesale sales network into a competitive network starting in the 1985-1986 time frame. Starting in 1995 or so, we took another step and expanded that operation and moved from just selling excess capacity to really being involved in the trading business. Since that time, we’ve probably grown the business at about 30 percent a year for the last four or five years. We approach it a little differently than some of the major traders. Yes, we are a commodity trader, but our focus is in niche markets. Our focus is on smaller scale markets where customers may need a more highly tailored product that’s more than just the commodity that can be bought off any of a number of exchanges. That’s where we’ve tried to make our mark and where we’ve been able to grow this business, not only with growing revenues and growing kilowatt hour sales, but with growing profitability. It’s a strategy that requires asset-backed transactions, so we have established a goal of doubling our capacity and tripling our sales in the next seven years. The WSCC market is a very competitive marketplace, but we operate in two worlds. One is this niche market arena in which we look at transactions or projects that may be too small for the big players and that are more customized—that’s been very effective for us. But also, we trade straight commodity. We’ve grown that business and certainly in the last couple years and this year particularly it’s been very effective and profitable for us. The challenge for people that enter into this market is to be able to make money in down cycles. I fully expect this marketplace to be one that goes through boom-bust cycles just like natural gas, copper—just like virtually any other commodity. Right now, we’re enjoying the opportunity of participating in the market to the extent that we are with market prices that are higher than anyone expected them to be. We’ve got some good resources that we can place into the market plus we’ve got some good trading talent that has developed a solid reputation with customers.One of the things that is unique is the culture that we’ve built in our trading operation. A lot of trading operations are focused on individual performance, each trader maintaining their own book with incentives built in based on how that trader performs. We have a team driven culture. All decisions involve at least two people, if not more than that, depending on the size of the transaction. There’s always a good balancing. We trade conservatively; we’ve put in place an efficient and effective risk management program that’s overlaid on our trading operation because our board and I are concerned about the financial risk that is undertaken in a commodity trading business.

EL&P: What is Avistar’s involvement with AMDAX.com, an Internet-based energy auction system?

Sterba: AMDAX is an Internet-based auction platform that is in its test phase. It has conducted three auctions in the California marketplace and they’ve all been successful. The reason we got attracted to AMDAX is due to a unique aspect that is still in the development phase and will be tested by the end of this year, at which time it will be rolled out throughout the California market—and that is the capability of doing buy- and sell- back transactions. For a commercial or industrial customer that has a 50 MW load, there are very few times when they are actually consuming 50 MW. The load pattern fluctuates hourly, daily, weekly, monthly, etc., and someone has to manage that load pattern and the customer ends up paying for that to be managed. AMDAX has developed a mechanism by which the customer can go to the market and buy a block of power for the year. With an electronic signal from the load, it will automatically go through and with a predictive tool determine how much the load’s going to be in next hour, five hours from now, 12 hours from now, 100 hours from now, and go through and buy and sell into the market to match that load. Consequently, it introduces a form of dis-intermediation, removing the middle players that take a chunk out of the economics for the customer. It is able to do that with, in this instance the California PX, efficiently. If that tool can be proven in its testing and its pilot implementation, it will be a distinguishing feature for the AMDAX product compared to any of the other products that I’m aware of in the marketplace. We’re very encouraged about the potential it may have. We intend at this stage to keep it focused in the California market and later move it into other markets. Our investment in AMDAX is about 20-25 percent.

EL&P: What are Avistar’s other areas of business?

Sterba: There are three areas: one is technolgy, and AMDAX fits into that; the second one is our meter services business [PHASER]; and the third is an energy services operation that’s focused on military and federal installations. Because of our PHASER business line, we’ve been working with Sandia Labs on predictive reliability tools and out of that may come another business called Reliadigm, which is geared to provide the next level of sophistication in reliability maintenance. It’s technology that to date has only been used for nuclear weapons and semiconductor manufacturing. It has powerful capabilities in terms of its optimization tools to help reduce maintenance costs. We’re using it right now in a test for our coal crushing equipment at San Juan.

EL&P: How would you describe your personal management style?

Sterba: There are a several components to the way I manage. My management style has evolved as my role has changed. The first is that I am a firm believer in setting high expectations and providing all the support that you can to bright, energetic people. There are some people that believe when you set high expectations, people can get discouraged. I don’t believe that. You set high expectations and people strive for that and when they make steps toward it, you praise the heck out of them and you give them all the support that you can to help encourage them and ensure they’ve got the resources necessary to get where they’re trying to go. Another of the changes in my style has been learning to ask more questions than providing answers. As I came up in organizations, one was rewarded for having the right answers. More and more today, it’s having the right questions and letting the experts bring the answers to the table that’s more important. Thirdly, things are moving so fast in this world today with people focused on trying to do their best. What sometimes is missing is context. One of a leader’s biggest responsibilities is to continually provide context so that people know how things relate—so they think more broadly by seeing they can impact something of which they had no knowledge. One of the things that we’re trying to do is to encourage people to experiment and try. When failure occurs, we recognize it, celebrate it and make sure that everyone understands what the failure was so it’s not repeated. We want people to try to do things differently and if we have as a slogan, ‘Don’t screw up,’ we’re not going to get many people to really try.

EL&P: What are your goals for PNM over the next five years?

Sterba: We want to complete the restructuring as required under the New Mexico restructuring act to position this company for the world of open access and competition. We want to do the absolute level best job that can be done in bringing customer choice to bear for our customers within New Mexico by positioning the delivery company as a neutral provider of services in which they think of their customers as both the retail customers that we have today and the competitive service providers. We want to make sure that we keep our eye on the ball about service to our customers and never think that’s just a mundane part of our business. With restructuring, we want to execute the plan to grow our energy-related business opportunities focusing on our generation and trading operation and how long we’ll stay in that business depends on what happens to the market. We have a delivery services business and we have a powerco business, but it’s not clear to me how long the strategies we’ve got in place will be able to be successful in the marketplace. We’re never going to be the size of Enron, AEP or Exelon. Today, we’re able to do well in the marketplaces as a nimble player because there are market inefficiencies that we take advantage of. How long will those market niches exist? That’s a question for which we don’t have an answer and I don’t think anyone has, but I feel a need to develop a third generation growth strategy that will probably be technology based.

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