Michael J. Zimmer
Baker & McKenzie
A number of major strategies for the U.S. power generation industry are being developed in corporate board rooms built around mergers, acquisitions, international project development, and the convergence of fuels, capital and electronic commerce with common local distribution properties. One of the missing links is the lack of marketing skills within the power generation industry as it moves to compete in a deregulated wholesale and retail marketplace. Market share is being bought, meters are being purchased, distribution customer lists are being acquired, and generation assets are being transferred through such strategic acquisitions or consolidations without the corresponding skills and insight to manage and market those new strategic combinations. In other instances, marketing talent is being acquired from other industries.
For example, within less than two months during the past year, three gas distributors were merged or acquired in Connecticut alone in this evolving competitive energy marketplace. What will these combined companies undertake for the future after consolidations driven by follow the leader strategies?
Enron acquired Portland General Electric and proceeded to announce shortly thereafter its movement from residential retail marketing in a number of key states in the region. This left the major strategic assets of Enron power marketing and trading focused on industrial and commercial markets in building new opportunities. How have the multiple strategies fared? Well, last quarter it was reported that Enron has Portland General Electric for sale and is moving on.
In other instances, mergers and consolidations are being driven by demands for increased generation, the convergence of fuels with electricity, and other strategic directions that do not reflect a sufficient retail marketing focus. What can be learned from these various experiences? Several themes emerge for further consideration:
1. Convergence with capital. Utilities enjoy a critical strategic edge in the potential convergence of fuels and electricity with capital and attractive rates. Utility marketing needs to be coupled with increased utilization of financial services, power and fuel trading, operations and maintenance, water, environmental services and other similar services to distinguish themselves from the other competitors in the field.
2. Increased utility spin-offs. Business units that labor under competitive pressures of regulation, codes of conduct and market power limitations as utility affiliates or subsidiaries should be prepared to be spun-off or introduced as growth companies into the financial markets on a stand-alone basis. There is little benefit from pursuing impaired or constrained services when removal of regulatory and market restrictions would open up increased opportunities for customer service.
3. State jurisdiction and political risk. Just as the 1980s were the decade of strong federal initiatives, the 1990s have been the decade of state regulation focusing on the environment, new taxation, economic development, plant divestitures, and post-federal Energy Policy Act implementation and electricity restructuring. Conflicting patterns of reg- ulation from 2000 on will spur strong political support for more restructuring of traditional regulation and for using federal pre-emption to manage such conflicts. Political risks for operating generating assets, taxes and rates are at the highest level in 20 years.
4. Limited fuels sector. The remaining fuels industries will be dominated by no more than two to three market players each in the oil, natural gas, coal and nuclear sectors. All other fuel management and development services will be converged into the electric utility industry. The challenge is in ensuring that natural gas and oil are not converted into a cottage industry of the electric utility industry as occurred with nuclear power and coal during the 1970s-80s. Such a development will have the attendant impacts on the future roles of those industries, market concentration and dominance with potential longer-term price consequences.
5. Increased distribution services. Increased distribution services must be marshaled by utilities against the fixed costs of distribution since market eco-
l nomics and capitalization now favor consolidation. The cost of metering, billing, mapping, collections and customer service should be leveraged into new product lines including both energy and non-energy services and resources to spread the fixed costs of distribution over broader units of demand.
6. Industrial service growth. Industrial customers are looking for more and better service. They also would find attractive increased time of day, seasonal services, quality of power maintenance, reliability services, storage, financial risk management, ancillary services, financing, billing analysis, aggregation, and industrial power island privatization as part of the fully integrated utility service profile of the future. Many subsidiaries and energy service companies still aren`t there.
7. Oil industry looms. The sleeping giant in the next stage of final industry development is the oil industry. With oil companies expressing difficulties to compete with $80 to $120 billion in annual revenues, it is only a matter of time before that concentration of capital and assets will be spread and diversified into other industry pursuits, including power generation.
8. Regional market shifts. The major regional markets will grow beyond the initial experiences in California and New England since 1995. The major markets will shift and focus until 2005 on the Middle Atlantic, Southeast, Southwest and Midwest regions where the needs for power and other market opportunities will continue until a period of market stabilization and consolidation occurs in the U.S. from 2005-2010.
9. Real-time marketing. Marketing and energy procurement will move for industrials from an annual planning to a more real time planning cycle reflecting variances in fuel use and availability, pricing, increased seasonal factors, storage and. Industrial marketing must adjust to this development, or move over to the full-time aggregators and power traders to reap the fruits of full retail competition.
10. Decline of project financing. In order to respond to emerging technology and merchant and spot marketing demands, current project financing structures will need to be abandoned. There will be shorter-term debt and new debt sources to meet market demands for new generation. Three- to four-year terms with bullets and balloons and refinancing requirements are becoming more prevalent. Projects also will be able to secure longer-term debt that is more consistent with the useful life of the assets. Ultimately, domestic financing might assume more of the trappings of corporate finance, securitization, leasing with more access to public debt markets through traditional finance techniques rather than project finance as the industry matures. Restructuring of distribution and transmission assets will create new bond transactions. The demise of the power purchase agreement (PPA) in favor of merchant plants is overstated. There is still room for longer-term commitments with price re-openers every two to three years to meet market demands and offer customer stability.
13. Repowering flourishes. Repowering will evolve into a major domestic market force of the next millennium after the current wave of acquisitions, divestitures and consolidations. Refurbishing older sites with existing infrastructure can be beneficial in meeting state integrated resource and least-cost planning requirements. The potential for higher market efficiencies will be an incentive to removing state regulatory barriers to repowering.
14. New transmission forces. Retail wheeling and satellite wheeling will become a major dynamic market force, and merchant transmission and private transmission development will need to occur. The momentum will come not from the federal level, but from industrial users, entrepreneurs and state public service commissions advancing transmission growth as an economic development tool. New regional transmission organization (RTO) rules will foster the demise of the entrepreneurial IPP industry. Major federal and state litigation will create some delays. This will create transmission “haves” and “have nots,” affecting the ability of states to maintain and attract desirable industrial bases.
The new electric power industry for the next millennium is a major factor in the U.S. domestic economy, a source of export and favorable trade balances, and enhances our ability to compete and provide products and services of value in the global economy. The preservation of that unique market edge will be an issue of major political and regulatory challenges into the next millennium.
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.