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<title>Buying Time: The New Electric Dialectic</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>March 1999</u><br>
</b></p>
<b><font FACE="Palatino" SIZE="5"><p></font><font face="Arial" size="6">BUYING TIME: THE
NEW ELECTRIC DIALECTIC</font></b></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:
03/99</em>)</font></p>
<font FACE="Palatino" SIZE="2"><p ALIGN="JUSTIFY"></font> </p>
<font FACE="Palatino" SIZE="2"><p ALIGN="JUSTIFY"></font><font face="Arial">Power business
strategists have all long since come to the conclusion that the unique monopoly service of
generation provision has become a commodity business, in which skill at cost control,
operating efficiency and price speculation through trading are the drivers of success. On
a parallel track, regulators increasingly derive self satisfaction from the increasing
conformity of their domains to true marginal cost competition. For all these players, the
power business finally seems to be fitting into that Economics/Finance 101 box we know so
well: valuation of alternative strategies discounted cash flow streams.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">This almost Newtonian certainty of how the world
works also is to be found in analysis of the current acquisition boom triggered by
deregulation, i.e. it is all interpreted as bidder match-ups of present value cash stream
analysis to corporate strategy. Sales of assets are driven by regulatory compliance or
core business focus. Purchasers are drawn of assets by one of three basic approaches:
economics of scale, initially through the fuel supply chain; asset backed trading of
retail and wholesale energy services and operational efficiencies based on improved
management of specific sites. Power strategies are thus characterized as all about
alternative appraisals of cash flow potential; different cost of capital hurdle rates and
different forward price curves for the regional markets into which the particular auction
is being carved.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Arguments about regulatory public policy in this
Newtonian DCF would therefore proceed from the question: are proposed contractual or
institutional relationships likely to promote the continued creative clash of competing
strategies? The ultimate criterion for blindfolded public policy becomes: is the playing
field really flattened? If it is, the presumption is that the economic results of the
marketplace will serve the public interest best – in terms of service and price.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">It turns out, however, that "rational"
businessmen participating in power auctions and greenfields investment decisions
increasingly may be thinking about their investments, in a different dimension than the
regulators assume. The challenging inference of this conclusion is that policy makers need
to re-examine whether the policies they establish really will elicit from competitors the
response from them best for the public. Space constraints permit only the outlining of the
new valuation private-public point-counterpoint in this column. It may, in fact, result in
a new regulatory policy dialectic.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Private Point: Strategy is viewed increasingly not
as a static event, validated by checking the DCF numbers. Each decision is viewed in terms
of the options over time it creates; and the quantitative valuation of a series of such
options. Strategy is not static; it involves the contemplation of the creation of a series
of such options. There have been two recent complementary articles in the Harvard Business
Review which explain this far more lucidly than can I, "Investment Opportunities Real
Options: Getting Started in the Numbers: (July-August 1995) and "Strategy as a
Portfolio of Real Options" (July-August 1998).</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">In the latter, the author, Timothy Luehrman,
introduces the notion of a very special garden plot called "option space"
defined by two metrics associated with the value of the option of being able to defer an
investment: The first is an old friend Net Present Value (NPV) enhanced by the value of
the ability to defer an investment, i.e. NPVq. (in effect, a value to cost metric). The
latter is a volatility metric, i.e. how much things can change before an investment must
finally be made (in effect, the impact of deferral on what NPV may be realized). Of this
garden plot, Luehrman says: "Option space can help address the issues an active
gardener will care about: whether to invest or not (that is whether to pick or not to
pick), when to invest, and what to do in the meantime." (It certainly appears that
our beloved power market is really just one subset of this "garden plot".) For
us as businessmen, while the further reasoning is complex and dense, the goal is clear: to
maximize profit.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Public Counterpoint: For policy makers, this
thinking on the part of private investors logically should be related to the deregulation
policies they should follow. Should regulators think in terms of maximization for the
private sector of option space? Or, should they fear that the pursuit of option space may
be contrary to reliable supply or equitable prices? Is it desirable for too few parties to
hold too much option space? Should regulatory focus be on market volatility reduction
and/or expedition of private decision-making even at the price of option space reduction?
Should it be on preventing the gaming of option space (as, for example, in the
transmission field)?</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">As merchant power men, we buy time and we bet on
time. Policy makers historically have sought public satisfaction at virtually every
instant as time passes; now the current vogue is to seek "ultimate" satisfaction
through free market stabilization. Neither analytic approach seems wholly appropriate. As
option space economics succeeds NPV as the actual basis for private decision-making, it
behooves public policy makers to factor this fact into their decision making also.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">The new energy policy dialectic, just like the old
song: sitting at the auction policy dock, buying time.</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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