By Michael J. Zimmer & Samir S. Desai, Baker & McKenzie
June 18, 2003 — Companies in the North American electric power sector face an uphill battle in today’s electric power wholesale and capital markets. A combination of general economic and industry crises has forced many participants to face difficult decisions to achieve their business and strategic goals until 2005.
A key component of any decision to participate successfully in the North American power sector on an ongoing basis is the evaluation, in financial and strategic terms, of electric power generation assets–whether to acquire or divest them. While there has been delay in this decisionmaking because of a variety of factors, an increased level of activity is expected in the second half of 2003 through 2004 with 90,000–140,000 MW of power projects in play in North American markets.
Future risks of the business
In completing the valuation to support the acquisition or divestiture, there are emerging risks to assess with market shifts still evolving:
Regulatory uncertainty. Rule changes, challenges in regulatory proceedings and in court and market protocol design and changes at the federal and state level will occur and change through 2005. New layers of regional regulation may be created.
Contracting risk. Can the price be effectively hedged in the transmission regime? Is a contract an effective agreement for the long term, or has the just and reasonable standard of review created a new “price majeure” risk to manage? Will the contract be grandfathered into any relevant RTO?
Market power and mitigation. Methodologies, price caps, ex post facto review make revenue streams unstable.
Transmission. Congestion management, transmission infrastructure improvements (on a utility and merchant basis) and transmission ratemaking are the next battle ground until 2008. Transmission risk is replacing environmental risk in the M&A evaluations; and is one of the most difficult risks to model.
Environmental and homeland security costs. Who bears these risks and costs of compliance? Regulated generation has better cost pass throughs than independent power generation for these cost factors.
Competition failures. What is the presence of affiliated power producers (APP) mean with private rate base options? This super generator status of APPs may make competition for sales by the merchant generators difficult to serve, while confronting hidden, unfair subsidies.
9-11 and terrorism. Risk of loss, liability and insurance costs are escalating, and should you seek Critical Energy Infrastructure protection at the FERC, passed through to the states?
Competitive bidding. In excess capacity, return to these techniques will occur with improvements from the prior regime, and increased use of integrated resource planning at the state level.
Debt, accounting & ratings shifts. These financial shifts, changes in accounting treatment on leases or tolling agreements will affect project valuations.
Zimmer is an international partner with Baker & McKenzie. He can be reached at 202-452-7055. Desai is a senior associate with Baker & McKenzie. he can be reached at 202-452-7057.