"SMDWhite (Flag) Paper Caper"
by Roger Feldman -- Bingham, Dana L.L.P.
When a "standard design" for the powerhouse is redesignated a "platform," it is a good indication that a political tornado has blown its roof off. Its chances of implementation must be questioned when even the revised paper’s issuance is not enough to deter the Senate Energy and Natural Resources Committee to vote to remand SMD to FERC and gag FERC’s issuance of orders until July 2005. It is understandable that there should be the resonance of a tinny arf to the Chairman’s reassurances.
What does FERC’s migration from White Paper to White Flag mean for the economic future of merchant and independent power, and the markets’ evaluation of existing power assets and companies? Remember – this is the same SMD that Standard & Poors recently explicitly asserted was critical to the resuscitation of the merchant power market.
Most of the analyses of the problems of the merchant power industry today boil down to identification of regional power supply-demand imbalances, breakdown of the market trading mechanism, flaws in local market design, and physical insufficiency of the grid to permit the type of trading that would reward new, more efficient units. The impact of all of these factors was multiplied by excesses in the financing of merchant companies and merchant plants, which now have created the overhanging ledge of necessary project refinancing and teetering distressed assets that, as likely as not, will bring new classes of equity investors into the market.
The original concept of SMD was to restore confidence in the deregulated model by remedying the flaws that experience with Order No. 2000 had highlighted, and by building out the framework for innovative development of the transmission system. In the process of doing this, since it involved change in the way the utility business was run and therefore overseen, a greater degree of Federal centralization was deemed necessary. That centralization appears to have been damaged permanently.
Consequently, in evaluating the practical ramifications of the FERC Wholesale "power platform" White Flag, the most important question is how the absence of its centralization will affect the real world financial situation which the capital markets face today. Response requires delineation of how the power markets would look if the platform was implemented as written, and consideration of how it would address the financial issues presented.
Broadly speaking (and subject to much technical clarification), the marketplace would have the following characteristics:
How useful will this "platform" be in responding to the issues facing the industry? The more probable answers are the following:
From the perspective of merchant power developers, therefore, the following conclusions are likely:
In sum, a period of not expecting too much change in favor of the independent and merchant players, and a solidification of the position of well-capitalized, service territory-based, integrated or partially-integrated utilities is to be expected. The capital market situation may emerge in which large surviving players are best positioned to take advantage of a more orderly RTO/ISO world where, while management of wholesale operations and trading are improved, incumbency in a given service territory is the trump card. The best financing mechanisms available for remaining independents and merchant facilities may be for plants whose projected output is discounted in value to modest commodity levels and backed by third party credit enhancements.
Before the industry and the financial community salute the new White Flag that FERC has hoisted, it may be time to offer new creative alternatives, e.g., transitional incentive structures that enhance the likelihood that there will be a deregulated industry of consequence after the shakeout of the next year is completed. Otherwise the White Paper caper will have yielded merchants’ floor prices and a shaky platform.
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.