By Heesun Wee
These are the dog days for power utilities. Spooked by accusations of unethical, if not illegal, trading practices in the wake of Enron's implosion seven months ago, investors have fled the sector in droves. Rating agencies have turned cautious. Their message to utilities: Reduce your debt. So, after years of building power plants or buying portions of them with little equity down, the utilities face the prospect of making hefty new investments without the benefit of using debt, or else their ratings could be cut to near junk status.
The negative news seems to be unending. The trend has hurt even staid utilities such as Duke Energy (DUK ), which on July 12 said it has received subpoenas from federal agencies requesting documents relating to its trading activities. Other utilities being investigated, or at least tapped to submit documents, include CMS Energy (CMS ), Dynegy (DYN ), El Paso (EP ), Reliant Resources (RRI ), and Williams (WMB ). The various investigations will take months, if not years, to shake out.
"BACK TO BASICS."
However, behind all the bleak headlines, a transformation of the deregulated electric power market is already starting to occur. That's true even for energy trading, one of Enron's specialties. The success of the transformation is crucial to U.S. consumers and investors alike, because it will determine whether they'll get the efficiencies and lower prices of a deregulated power market -- and not the abuses that cost Californians billions and helped drive Enron into bankruptcy.
The companies are refocusing on their traditional core businesses: generating and delivering electric power. "We're really in a climate of back to basics," says Gideon Moor, a research analyst at Miller Howard Investments in Woodstock, N.Y., which offers utilities-focused funds.
The changes sweeping the industry stress clarity of finances and operations, and far less risk. U.S. utilities are frantically scaling back their diciest operations. Wholesale energy services -- including managing other businesses' power needs and energy trading -- are prime targets for cutbacks. El Paso, Williams, and Aquila (ILA , formerly known as UtiliCorp United) are just some of the many companies to recently announce plans to cut staff and commit less capital to their wholesale energy businesses.
Accounting practices are becoming far more conservative, too. When utilities record wholesale marketing and trading activity on their income statements, for example, those figures incorporate anticipated, not actual, prices for electric power. Using various company and industry measures, the companies are often able to make quite accurate short-term estimates. But it's far harder to forecast longer-term contracts -- say, 16 to 18 months out -- and there's a lot more opportunity to fudge the numbers.
To avoid the appearance of impropriety, many utilities are simply inking more short-term deals. "There's now a strong awareness that these [long-term power] curves can be manipulated," says Art Altman, an energy expert at the Electric Power Research Institute, a consultancy in Palo Alto, Calif.
Despite the changes, a fair number of the U.S. giants are likely to become takeover targets, as European outfits seek to gobble up utility assets. Big Euro utilities have solid balance sheets and few acquisition possibilities at home. And with cash-starved U.S. utilities trying to shore up their balance sheets by selling assets, the price is right. Likely acquirers include Germany's RWE and E.ON, and Britain's International Power and National Grid, power experts say.
Meanwhile, the Federal Energy Regulatory Commission (FERC) is hashing out a suggested model for the national wholesale power market. The thinking is that new guidelines are needed to allow everyone from regulators to transmission-grid operators to keep better tabs on local power markets. Shenanigans like Enron's allegedly questionable trading practices would probably pop up on regulators' radar screens a lot sooner if markets are revamped.
"In California, they set up the rules that allowed traders to manipulate the markets. Those traders are culpable, but they couldn't have done that if the rules were different," says Ed Krapels, director of natural-gas and power services for Energy Security Analysis, a consultancy in Wakefield, Mass.
FERC is likely to model its proposed national energy trading market on PJM Interconnection, a not-for-profit Valley Forge (Pa.) company that operates a large power grid and is responsible for running the largest wholesale power market in the world. One key element of PJM's market is "locational marginal pricing," or LMP. Using standardized Internet interfaces, data formats, and computer software, buyers and sellers of wholesale power who use PJM have access to current data on local power demand, supply, and prices. Numbers are updated every five minutes on the Internet, explains Andy Ott, executive director of markets coordination at PJM.
Krapels and other power experts argue that such localized, close-to-real-time data make it much more difficult for abuses to go undetected. The absence of such data in California hampered the state's ability to keep tabs on local power glitches -- flare-ups that might have been caught before rolling blackouts became necessary in 2001, as demand outstripped supply, some experts contend. "I think the system is definitely fixable," Ott says.
One stumbling block is that FERC has little regulatory authority in key energy states such as New York, Florida, California, and Texas. But the hope is that all states will adopt FERC's model, or something close to it, in the interests of creating a national market and stamping out abuses.
Indeed, California plans to adopt LMP once it receives federal regulatory approval. The change will impose many strict rules to ensure that wholesale power markets are more transparent and fair. After a rowdy few years of a frontier-style deregulated power market, energy experts argue that's a small price to pay to get energy deregulation back on track.
In the meantime, the sector's stocks are likely to move sideways at best, barring any new revelations about deregulation abuses. A rebound will begin at some point, though it's too early to call the timing. Acquisitions could help get share prices moving up, but regulatory questions about possible foreign acquirers may also work to keep this sector on ice for the near term.
Wee covers financial markets for BusinessWeek Online in New York
Edited by Beth Belton