Power: Keep The Candles Handy -- And Light A Few

For the power sector, 2003 will be remembered as the year the lights went out. To avoid another blackout like the one that darkened big chunks of Canada and the U.S. in August, the industry will work harder this year. But it's unlikely that either the administrative overhaul needed to run the grid better or the many billions of dollars required to modernize it will materialize. Even though the U.S. will generate enough power in 2004, the lights may still go out.

Despite some progress, none of the plans under way addresses the fractured supervision of the nation's web of wires. A November report from the U.S.-Canada task force investigating the North America blackout puts the blame on equipment failures, coordination problems, violations of reliability standards, and human error. One main culprit: FirstEnergy Corp. (FE ), which failed to perform simple tasks such as preventing trees from downing power lines. In response, the North American Electric Reliability Council is drafting new reliability measures, and state public utility commissions are trying to make sure local utilities do a better job taking precautionary steps, including trimming trees. Congress' energy bill, which failed to pass this year, also included some promising measures. It would have made reliability standards mandatory instead of voluntary, and it would have given the Federal Energy Regulatory Commission the power to order the placement of transmission lines in urgent cases.

Chances are good that some version of the energy bill will pass in 2004, but for now there's more talk than action -- or money. The Electric Power Research Institute estimates it would cost $5 billion to $10 billion per year over the next 5 to 10 years to modernize the system properly. The required fixes include faster digital switches, software that improves communications between different regions of the country, and additional power lines. But the pace of investment -- running at $3 billion a year, according to the Edison Electric Institute -- is too slow to put these upgrades in place.

That's because the utility industry has bigger worries than frayed transmission lines -- not least of which are massive credit woes. Overall, the industry is weighed down by a mountain of debt. Pacific Gas & Electric (PCG ) alone has a debt of $12 billion, which forced it into bankruptcy two-and-a-half years ago. A December bankruptcy settlement will stick consumers with up to $8 billion in surcharges over the next nine years.

The financial woes mean the coming year will bring more restructuring in the sector. Utilities are expected to hawk power plants and other assets to stay solvent. "What you're going to see," says Tom Baker, president of Dallas-based TXU Energy (TXU ), "is a...strengthening of the balance sheet: shedding debt, reducing costs, and improving liquidity."

The restructuring may also get a boost if the energy bill passes. The 2003 version of the legislation contained a provision repealing the Public Utility Holding Company Act of 1935, which constrains utility holding companies from diversifying. They are, for example, unable to use their profits from regulated businesses to expand into for-profit power generation in other states. Getting rid of the law, analysts say, could trigger a wave of mergers and consolidations. The bill's proponents say that the measure would make the sector more efficient. Opponents fear that this may lead to the creation of huge utility holding companies with monopoly power.

In the short run, though, the restructuring should help bolster the industry's bottom line. But it may not stave off another summer of blackouts.

By Stephanie Anderson Forest in Dallas, with Peter Coy in New York

— With assistance by Peter Coy

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