Four issues keeping energy executives up at night

Gregg W. Harris & Jeremy A. Hushon, Fulbright & Jaworski LLP

The energy industry currently is facing a significant period of retrenchment and challenges as financial markets, political pressures and events such as the Northeast blackout continue to affect the participants in the field. Energy company executives are confronted with a broad range of challenges that are having an impact on significant portions of the industry. Set forth below is a brief discussion of certain important issues involving financial, regulatory and environmental concerns faced by energy companies today.

1. Financial health and related borrowing costs

One of the challenges facing many energy company executives is that of returning their companies to financial health. Improving the financial picture of an energy company, in most cases, will require lowering debt burdens and attracting cheaper financing to retire existing debt and to fund new investments. Falling credit ratings have complicated the turn-around process, as lower ratings have triggered debt repayment obligations on existing financing and increased the cost of new loans to affected companies. Of course the general state of the U.S. economy undoubtedly also will have a considerable impact on such turn-around efforts.

The industry-wide scope of financial problems has also meant that energy companies have been affected by the creditworthiness of other contractual counterparties. For example, the increased cost of borrowing faced by natural gas pipelines may be attributed not only to the lowering of the pipelines’ credit ratings, but also to lenders’ concerns about the creditworthiness of the pipelines’ customers.

2. Liquidity crunch and resulting asset sales at depressed prices

Asset sales have become a frequent tool used by energy companies to obtain greater liquidity. In order to alleviate severe liquidity crises, some energy companies have had no choice but to sell productive assets on an expedited basis, often at depressed prices. Ultimately, these asset sales may increase the severity and length of the financial troubles facing a number of energy companies, as potential long-term revenue is exchanged for short-term liquidity needed to make debt payments or pay other expenses.

Sometimes one party’s plight is another’s opportunity, and the liquidity crisis facing many energy companies has created an opportunity for other companies, in particular those with cash or access to reasonably priced credit (including a number of non-traditional players in the energy industry), to purchase productive assets at depressed prices. For example, a number of investment banks and private equity funds recently have been active in purchasing energy assets.

3. Regulatory issues

A. Regional transmission organizations
Among the most noteworthy of the ongoing regulatory issues impacting the energy industry, the Federal Energy Regulatory Commission (FERC) has encouraged (and many think in the future may require) public utilities that own, operate or control interstate transmission lines to join regional transmission organizations (RTOs). An RTO consists of multiple transmission companies whose lines (as well as any generator’s access thereto) collectively are governed by a single umbrella organization. FERC adopted its RTO-related order with the hope that it would lead to greater administrative efficiency and a reduction in pricing disputes. Thus, for example, a generator could access transmission lines across an RTO’s territory under one contract and at one price, instead of having to contract with multiple parties at each leg of the transmission process. Leading opponents of RTOs to date have included many state regulators that view FERC’s oversight of RTOs as a federal intrusion on states’ rights and also have included transmission companies that have been successful without the imposition of RTOs.

The recent blackout in the Northeast is sure to heighten the visibility and potential impact of FERC’s efforts to establish RTOs. In particular, discussions are likely to focus on whether mandating formation and membership in RTOs coupled with increasing RTOs’ authority over local utilities and transmission companies would help to prevent future blackouts. Heightening the urgency of resolving the debate over RTOs, energy companies likely will be reluctant to approve additional investments in transmission systems until the future landscape of the transmission market is settled.

B. Standard market design

Related to the issue of RTOs is FERC’s Standard Market Design (SMD) initiative. The purpose of the SMD initiative is to establish a standardized set of rules and tariffs regulating access to transmission lines. Supporters of the initiative say it ultimately will result in efficient energy transmission and lower costs for consumers. Opponents assert that the initiative is another instance of federal power grabbing, and that FERC’s current approach ignores regional realities that prevent a uniform application of pricing and access plans. Although further changes are likely to be made to FERC’s proposal as it goes through the rulemaking process, FERC has made it clear that enacting a SMD initiative will be a priority in the coming years.

4. Environmental issues

A new rule promulgated by the Environmental Protection Agency (EPA) is poised to dramatically change the way power plant owners and operators make decisions about facility upgrades and modifications. First included in the 1977 Clean Air Act amendments, the New Source Review (NSR) provisions require power plants and manufacturing facilities to implement the best available anti-pollution devices whenever a facility undertakes a major modification or expansion. Determining the parameters of the term “major modification” has led to over two decades of litigation (including a number of ongoing cases) with numerous judgments entered against power generators for violations of the Act. Ending a lengthy review process, the EPA issued a final rule rewriting the NSR requirements on

Aug. 27, 2003. Under the new rule, significant safe harbors have been added to the exclusions for facility modifications from the NSR requirements. While being hailed by energy leaders, the new rule faces serious obstacles in Congress, among numerous state attorneys general and in ongoing litigation before it will become the national standard.

Harris is a partner and Hushon a senior associate with the Washington D.C. law office of Fulbright & Jaworski LLP. Fulbright & Jaworski LLP, a full service law firm with over 800 attorneys located in 11 offices in the United States and overseas, is a firm with a diversified practice that serves the needs of the global energy industry.

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