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<title>Sphinx Redux Dangers</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<td width="75%" valign="top"><img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" WIDTH="375" HEIGHT="75"><p><b><u>December 1997</u><br>
</b><br>
<font size="6"><strong>Sphinx Redux Dangers</strong></font></p>
<p><strong>by Roger Feldman -- Bingham, Dana and Gould, P.C.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine Magazine:
04/98</em>)</font></p>
<p> </p>
<p><font face="Arial">A good vantage point for private power is to understand its
opportunity profile is to consider the "negative space" implications of the two
fundamental utility strategies which are unfolding in response to deregulation: (1)
divestiture of the generation with which they have served their traditional franchise
territory; and (2) off set of divestiture revenue losses through new acquisitions of
assets in other locations and power marketing sales backstopped by those acquisitions.
Clearly the former strategy leaves private power with more running room than the latter.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">With respect to the first strategy, there remains
healthy skepticism among a large number of utility executives as to the long term
competitive viability of utilities as pure T&D companies. The rating agencies have
begun to express fear that, in effect, self (or regulatory commission) -inflicted
"adverse selection" is at work in current divestitures by utilities, i.e. that
utilities will be left holding the least market competitive generating assets in their
service territories, i.e. nuclear plants and non-repowerable facilities, and not
necessarily recovering their value through stranded cost payments. Even more
fundamentally, analysts have begun to question the validity of the characterization of the
remaining "rump" T&D utilities as scaled down but still stable revenue
versions of their larger vertically integrated, aggregated selves. Key factors of concern
are regulatory pressure to provide lower distribution rates (without regard to cost),
partly in reflection of traditional ratepayer oriented regulation policies, e.g. lifeline
rates, disconnect policies partly as a result of subjection to performance-based
ratemaking unrelated to actual operating circumstances. In effect, rump utilities left
holding the bag for a customer base of uncertain size (due to retail access); high cost
(due to reduced overhead spreading and possible non-compensation for the full cost of
purchased power. In addition, T&D companies may be pressed into service to collect the
stranded cost charges which they seek to securitize to offset the loss of stranded
generation, and thereby pressed into an unwelcome visibility when they deliver their
bills, which could impair their efforts to enter "brand name" competition for
power marketing.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">As a general matter, of course, the private power
industry has been pleased to allow the utilities to fantasize themselves into comfort with
this impending situation: to proclaim "freedom" from the tie to the old
machines; pleasure with the planning out of market forces; preference for increasingly
dicey overseas investments; humble though secure comfort with regulated returns. They have
gone further fighting to assure disaggregated abstinence by barring utility energy service
and power marketers "branding" in their old service territories as an unfair
competitive development.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">But it should not become too smug too soon and be
diverted by (quiet) derision of the penitent from taking cautious note of their shrewd
brethren, who are hastening to substitute a better new capacity mix suitable for
generation competition (in other service territories if not their own) for that generation
which they are being forced to divest. The names of the large competing utilities may
change even though the economic clout does not. The canaries in this particular coal mine
of potential competition by disaggregated utilities are the major power marketers, who
have been taking note of the failure of FERC to adequately assure that transmission system
reform under Order 888 is being implemented in a manner supportive of level playing field
competition. Among the issues which the power marketers are surfacing are several
indicative of residual strength of the strategy of several leading utilities seeking to
arise sphinx-like from the ashes of compulsory divestiture by following the alternative
strategy mentioned above: attaching new power heads to old T&D rumps. The issues
raised by power marketers center on transmission issues which have not been resolved
fully. These include the following: - The ability of vertically integrated utilities to
arrange for their transmission arms to acquire T&D for captive customers and thereby
gain insulate themselves through state (rather than Federal) regulation of transmission
service, from potential competition. - The ability of vertically integrated utilities to
obtain transmission capacity outside of OASIS operations. - The ability of utilities to
use their rights to serve native load under Order 888 as a basis to, in effect, hoard
capacity. - The potential adverse impact on non-utility suppliers of NERC tagging.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">The upshot should be clear for private power: it
should not assume (1) that utilities will go quietly into the generation night, or (2)
that apparent utility strategist’s acceptance of the FERC "new look" will,
by itself, result in market reshaping on a truly competitive basis. Even with regional
ISOs, there still can be market skews favorable to utilities and adverse to themselves. In
short, for private power to have long term success, rump redux will not do.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Beware the re-emerging sphinxes.</font> </p>
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<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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