Michael J. Zimmer
Baker & McKenzie
The independent power (IPP) industry faces the highest dimension of political risk, regulatory uncertainty and market challenges over the next five years. A number of key market issues (driven by patterns of regulatory change) could impact the long-term health and performance of the industry. Originally the industry was spawned by the provision of strong regulatory and tax incentives to promote successful non-utility generation and development. These initial inducements were overtaken by the forces of competition and project development through the provision of regulatory market supports, competitive bidding and least-cost planning at the state level. Finally, competitive market forces (controlled during the past decade as power) matured into more of a commodity industry, while price (through marketing and trading) became the critical arbiter of service. This created the current transition environment in which regulatory risk is at the highest level the industry has faced in its brief history. When converged with overbuilding and plummeting asset valuations, the combination could be deadly.
Frequently, IPP developers have faced regulatory risk and consequences in the development of international projects during the past decade. Special forms of political risk insurance coverage and special government programs have been put in place to manage the volatility and uncertainty associated with the political and regulatory dimension of project development in international markets. However, political and regulatory issues loom large for future development in the United States. New patterns of regulation raise concerns in several critical areas. These risks can’t be managed through political risk insurance but will instead require transmission system management, contracting risk management, and technology and market intelligence to avoid generation ownership disasters. Key considerations include:
- SOx and NOx regulations, the impact of implementing new requirements of the Clean Air Act and regulation of precursor emissions for NOx and ozone in a 22-state region. Emissions trading and credits will be part of the solution.
- The prospect for new World Trade Organization regulation impacting foreign companies entering the U.S. marketplace and the reciprocal treatment of U.S. companies as they pursue the next phase of international project energy marketing and trading and energy services.
- New incentives to provide emissions credits to implement on a market basis-the impact of the Kyoto Accords and drastic reductions in emissions to enter world and global compliance by the year 2010.
- New FERC forms of regional regulation, regional transmission organizations and the prospect for impacting new forms of concentrated service for transmission in the future. This is just an interim step before the final end game, along with managing new layers of regulation pricing dysfunction and jurisdiction.
- Regulatory approvals for mergers creating new generation concentration in the marketplace. Twenty companies are forecast to control 75 percent of generation, and 10 companies will control 80 percent of gas and power marketing and trading in the near future. The pricing and market concentration impacts are yet to unfold.
- The lack of standard tariff requirements governing interconnections on individual systems and regional transmission organizations. These negotiations have emerged as the next major tool for market disruption and delays, along with standby and backup power rates. Interconnection and standby power procedures must be streamlined, standardized and posted timely in public tariffs to eliminate market concerns.
- Generation imbalances on energy and capacity. The cost for imbalance services and how imbalances are monitored and measured arises with frequency in the Southeast and Southwest. Behind-the-meter generation issues are also appearing in New England and Texas.
- EPA regulations under the Clean Water Act, which could change how states manage water quality and set discharge limits for power plants and other facilities.
- EPA’s consideration of new and significantly expanding discharges along certain critical bodies of water to obtain offsets for 1.5 times their increased discharges. This proposal would disfavor both new and repowering projects and could harm plant acquisition and divestitures.
- Particulate and air toxic regulation that will impact generation facilities within the next five years. Impacts will be more extensive on new projects, repowering facilities and new plant acquisition strategies.
- Changing state tax policies because of utility restructuring, which have been compounded by the Internet tax debate. The fiscal impacts and possible changes are still being devised.
Knowledge and experience will ensurethe proper management of these regulatory issues, which will require increased asset development and skills built around:
- regulatory market knowledge;
- advanced knowledge of transmission systems and ISO procedures;
- comprehension of the impacts of these regulatory considerations on site/market selection;
- environmental regulation shaping technology options and deployment;
- use of partnerships and alliances to better manage regulatory risks; and
- capacity operational efficiencies and opportunities.
Without these, owners, operators and developers own generation assets at their peril. When regulatory and political risks converge with the spectre of overbuilding, plummeting asset valuations, and weak O&M capabilities and technology deployment, the industry could suffer in stability, project economics, reliability and customer service. Artificial regulatory intervention, asset hoarding and dumping, and volatile manifestations of market behavior will evolve in the future because pro formas, economic models and forward curves do a poor job of modeling panic. Managing that political dynamic is a major U.S. market challenge for the future. Otherwise these forces could converge to make power failure the next major energy crisis.
An international partner with the law firm of Baker & McKenzie, Zimmer has been providing counsel to forward-thinking power companies since the 1970s and has represented the industry’s leading companies in matters of project finance and law.