Storm Winds of 2005
by Roger Feldman -- Bingham, Dana L.L.P.
(originally published by PMA OnLine
The future of merchant power
depends on where capital will flow in the future. Presently capital — from
new sources including hedge funds, private equity and other special purpose
funds — has been directed to the trading of existing assets, not the
development of new facilities. As these plants age, and their contracts
expire, those existing assets become “merchant” in their own right. So too
do distressed assets emerging from Chapter 11. The regulatory environment
for them becomes even more pertinent.
Evaluation of the Energy Policy
Act of 2005 therefore requires comprehending the entirety of the Energy
Policy Act of 2005. That’s why the run-down which follows of the Act is
entirely pertinent to all players in the development or the resuscitation of
the merchant power industry.
Viewed from the perspective of
impact on capital flows into the utility industry, significant provisions of
the Energy Policy Act of 2005 (“Energy Policy Act”) may be grouped into four
1. Those provisions liberalizing
the ability of parties to innovate in their purchase and sale of market
2. Those affecting the
predictability of regulatory treatment of the industry.
3. Those opening or closing new
capital outlets for investors or potential investors in the power industry
or related energy areas.
4. Those possibly diverting
capital investments to nearer term opportunities in the energy field.
Here is a brief rundown of
conclusions on each of these issues and a brief summary of the Act’s
provisions which support them. In the course of the next two days, it will
be informative to get the panelists’ views on this characterization and
evaluation of the Act.
INNOVATION-PURCHASE & SALE
1. The repeal of PUHCA,
even though accompanied by redelegation of certain reduced authority to FERC
and preservation of residual state authorities should enlarge the
marketplace for new non-utility investors; contribute to consolidation of
utility companies and will place pressure on traditional IPP ownership
models of entities. This will be facilitated by the Act’s partial
streamlining of the merger approval process.
* Title XII, §§1261-1277
of the Act repeals PUHCA, which provided for, among other matters, SEC
advance approval for acquisitions creating holding companies (10% ownership
or more); holding company securities issuances; intercorporate transactions;
and multistate or geographically discontinuous ownership of assets. The Act
effectively limited third party, e.g., private equity, managerial control of
utilities and placed limits on the non-utility business activities of
foreign acquirers. To be substituted within four months of the Act is FERC
(and state) review of books and records related to rulemaking and regulation
of certain transactions among holding company affiliates. FERC now also has
regulatory authority for review of holding company system overhead and cost
allocations. Note, however, that the Act does not repeal state authority
over acquisitions, nor the merger review authority of FERC, DOJ and the NRC,
* Since a key element in
FERC “public interest factor” review (as well as DOJ and FTC) is the
competitive impact of the merger, proposed mergers of utilities of the same
geographic market will continue to be examined for adverse impacts.
Specifically, Federal Power Act § 203 remains in place, as amended by Act §
1289 merger review provisions. Key streamlining features of this review are:
contemplated in the act required FERC adoption of procedures for expedited
consideration of applications. (Actions not acted on in 360 days are deemed
* Under the Act, however, there is broad expansion of the types of
transactions over which FERC would have jurisdiction. Sale of generation
assets only (even without transmission or other “jurisdictional assets”) is
now to be included within FERC purview, if the generation assets are used in
interstate sales; as are mergers of (a) holding companies and transmitting
companies now subject to FERC jurisdiction; (b) utility - non-utility
subsidies and (c) cross encumbrances of assets.
PREDICTABILITY OF REGULATORY TREATMENT
2. The basis emphasis of the Act is on creation of a more reliable grid,
in which efficient dispatch has been bolstered, although not enshrined in a
single standard market design. Efforts to improve the transparency of the
trading markets and preclude their non-manipulation are enhanced. While open
access continues to be supported as general matter and expanded to other
grid participants, the effective gutting of PURPA and absence of other
“wedge” measures for nonutilities to capture utility credit suggests a
further force for centralizing control of the utility industry. The
optionality value of investments will have to be assessed with this
consideration in mind.
* The other primary
thrust of Title VII is to further facilitate the rationalization of the bulk
power system, although not in the fully detailed manner contemplated by
Standard Market Design. The key element under §1221 is the certification of
an Electric Reliability Organization (ERO) to develop reliability standards
which may be enforced by the, Commission, ISOs or RTOs as designated.
Re-enforcement is provided for FERC’s authority to assure non-discriminatory
access not only to IOU but also to non-regulated transmitting utilities
under §1231. (PMAs and TVA are now also authorized to participate in RTOs).
* Importantly, however,
under §1233 the rights of load serving entities to protect their ability to
provide firm transmission service to “native load” on a priority basis is
protected. Retail utilities thereby are enabled to afford themselves
preferential transmission access to serve their “own retail customers.”
* Reflecting a similar
Congressional inclination to bolster the transmission system but reduce the
extent of non-utility players in it. Subtitle E §§ 1251-1254 amends PURPA in
a manner which, in effect, guts the requirement of compulsory“must buy”
utility purchases and utility “must sell” provisions which enabled QFs to
optimize their power export capability. These capabilities in particular
provided a basis for the “QF” industry which has existed since the ‘80s. The
“must buy” requirement only applies if a regional market is not
“competitively workable” - a subject for dispute outside of RTO regions. (It
does not undercut state utility required purchase standards for renewables.)
The definition of qualified “cogeneration” has been shrunk to basically
limit the use of cogeneration to the non-utility marketplace, while
expanding utility ownership.
IMPROVEMENT OF TRADING MARKETS
* Markets using the grid are to be strengthened, FERC is directed by §§
1281, 1282 to enhance the power trading market by strengthening its
oversight and governance of abuses.
Price transparency will be actively facilitated by FERC, including the
issuance of rules for the dissemination of information about the
availability and prices of wholesale electric energy and transmission
service. Injunctions may be obtained against persons engaged in market
Rules to prohibit the filing of false
information and the use of “any manipulative or deceptive device or
contrivance” will be published. FERC is also directed to enter an MOU with
POWER INDUSTRY INVESTMENT-TRANSMISSIONS
3. The power industry activity to which most incentives for innovation
is given is transmission — both for investment and development of new
companies. In addition, the incentives for clean coal and nuclear facilities
may have a longer term influence on the market. Analogously, the regulatory
incentives for LNG should both attract further capital to this sector and
storage, but also may provide needed support for large non-distributed
sources of generation.
* The primary focus in Article VII Subtitle D on “Transmission Rate
Reform” is capital creation within the electric power industry is
transmission. Incentive-based ratemaking for transmission facilities is
specifically authorized to encourage investment and participant funding
plans (even by non-RTO members). There is also to be encouragement of
deployment of advanced transmission technologies. Taken together with the
PUHCA provisions permitting freer asset transfer, the possibilities for ITC
creation are enhanced.
* Possibly also facilitating development of transmission is an effort to
emulate the right-of-way siting authority which FERC has exercised with
respect to interstate gas pipelines (backed by eminent domain authority).
The DOE is required to designate “national interest electric corridors” in
areas with capacity constraints or congestion.
Where states do not authorize or otherwise impair project development, a
procedure for Federal eminent domain and “just compensation” — is provided.
It may or may not be sufficient to deal with all the permitting requirements
presented at the Federal and state levels.
4. A significant proportion of the Energy Policy Act tax incentive program
as well as loans, grants, loan guarantees, and research & development grants
are directed toward renewable electric energy technology including biofuels.
Analogous incentives are directed toward
coal-based alternative liquid and gaseous fuels. Some capital otherwise
directed to utility finance seems likely to be diverted in those directions
— particularly where the financial credit of utilities or refiners can be
captured in structured deals as a result of Act incentives. Other high tech
loan guarantees and R&D incentive programs seem less likely to have near
term private capital diversion potential.
* Of potentially greatest significance in
terms of capital market diversion from traditional utility assets are the
tax incentives provided for different types of renewable energy resources,
notably Production Tax Credit for power production from specified qualified
energy resources. Title XIII extended the availability of these credits
through 2007; enlarged the list of Qualified Energy Facilities and extended
the term of the credits for certain of these resources to 10 years. The
non-refundable PTC is as much as 1.9 cents per kilowatt hour.
Merchants and other transitional assets must be acute to catch the winds of
change which the Energy Policy represent. The Energy Policy Act can be a
helpful gust or a storm warning.
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.