Energy Markets at Crossroads:
Has Deregulation Failed?
International Association for Energy
Economics
John J. Stauffacher
Electricity:a Market in Transition
One foot (at least) firmly planted in the past
Much uncertainty from lack of clear
direction
The good old days and stranded costs
Part of the political price that had to be paid
Distortion of competitive options
Hidden agenda for many participants decisions
Electricity:a Market in Transition
Deregulation or restructuring for a competitive
market?
Limbo of neither
Legislative indecision
Jurisdictional turf battles
Market failures or failure to let the market work?
California—leaping the chasm to two bounds
Failure in confidence in markets and participants
Electricity Market Structure
New state legislation often mandated or
encouraged functional unbundling
Addressed market power concerns
Quantified value of generation assets
Brought in new players and new ideas
Sellers market
Existing assets allowed fast market penetration
Higher prices minimized stranded costs
New facilities faced many barriers
Financing new Infrastructure- an
evolution of lending philosophy
Rate base assurances—just be Just &
Reasonable
New entrant QFs and IPPs—relied on
obligation to purchase or LT contract
Merchant plant—non-recourse project debt,
high leverage
Financing new Infrastructure- an
evolution of lending philosophy
Late 1990s shortages and price spikes (signals)
brought a wave of investment
Prices for divested generation escalated
Reality of slow demand, over supply and resultant
lower electric prices
Year
Avg Sale Price X Book
2000
$430/kw
1.8
2001
618
1.7
2002(10 mon)
305
1.7
Financing the industrycan electricity survive a
“boom/bust” cycle ?
Political will to let prices reflect
supply/demand
Regulatory certainty in the treatment of
purchased power
Maintaining sufficient market number of
healthy participants
Financing the industry—
the Role of the Rating Agencies
140
120
100
80
upgrade
60
downgrade
40
20
0
2000
2002
Rating Agencies
credibility suffered big
time from the fall of
Enron
Electric Industry
paying ever since
Electric industry
“taint” and “headline”
risk
Financing the Industry—
Rating Agencies and the
Financial Markets
A “credit Armageddon” looms?
Major problems ahead- $90B of refinancing
by 2006 (20% non-recourse)
Adverse off shore experience draining many
deep pockets
Buyers market but few buyers—is market
power the next major problem?
Sorting it all out—Can a healthy
Electric Infrastructure emerge?
Project debt collateral is the facility itself—
an efficient, clean and generally well
located facility
Under resourced load pockets exist—
despite NERC’s rosy forecasts—24%
reserve margin by 2005
But, investment in Transmission
infrastructure seriously lags
FERC’s Answer to the Transition:
Standard Market Design
Goal to create a seamless transmission
market under a single tariff
Addresses congestion through LMP
Tackles key issues including congestion
revenue and resource adequacy
Natural gas has shown it can be done
FERC’s Answer to the Transition:
Standard Market Design
Pat Wood“the status quo is wrong if [it] overrides the
Federal Power Act requirement to treat all
transmission customers the same”
Nora Brownell“political pressure can not change the reality
that significant change is needed to ensure
investment to meet both our short terms and long
term transmission and generation needs”
FERC’s Standard Market Design
Many vocal opponents and proponents
Strange bedfellows—EEI and NARUC, EEI
and NRDC
Jurisdictional questions heated
Regional differences touted
Timeline and likely judicial challenge
Railroad Standard Gauge- a
regional differences analogue
Prior to 1880’s both narrow and wider
gauges used
Technical arguments
Regional arguments
Economic interests
Eventually a uniform “standard”gauge was
accepted—4 foot 8 ½ inches—the uniform
width of Roman war chariots wheels
Industry Response to Current
Crisis
EPSA Code of Ethics
CCRO White Papers on Best Practices
Withdrawal from Power/gas marketing
Deferred or canceled capital additional
Focus on cash flow and balance sheet
Sale of assets
EPSA Code of Ethics and Sound
Trading Practices for Electric Power
Suppliers
• Defines and reaffirms the values, principles and
internal controls that electric power supply companies
must follow
• Complements the internal principles and practices of
each individual company in supplying power,
managing risk, providing market liquidity and
reporting financial results
• Assures that unethical trading practices are not
tolerated and that public disclosures are accurate
EPSA Code of Ethics Guiding
Principles
Integrity
Sound Trading Practices and Principles
Candid and Complete Disclosure
Comprehensive Corporate Compliance
Integrity
Business activities should be conducted in an
honorable and principled manner consistent
with the Code’s ethical standards and sound
trading practices
• Engage only in transactions with legitimate
business purposes, such as managing business
risk or that otherwise have economic substance
Integrity (cont)
• Honor contractual obligations
• Maintain risk management activities designed to
ensure that power-trading activities are conducted
in accordance with this Code
• Report financial results so as to fairly present the
financial health of the company
• Not engage in any transactions intended to boost
revenues or volumes artificially, or intended to
manipulate market prices
Sound Trading Practices
• No unlawful withholding
• No creation of artificial congestion
• No intent to offer and not provide reliability
services
• No “wash” trades
• No misrepresentative trading
Candid and Complete Disclosure
• Provide accurate and transparent market and
transaction information
• Adhere to procedures to ensure that all trades are
properly and timely documented and that no trades are
concealed or misrepresented
• Maintain documentation on all transactions
• Ensure that any public information is accurate and
consistent
• Continue to cooperate with regulators in their
oversight of market operations
Comprehensive Corporate
Compliance
• Maintain a compliance program that will assure
appropriate, timely and ongoing review of power trading
activities in compliance with this Code
• Personnel training on the provision of this Code and the
company’s risk management policies
• Encourages employees to disclose to senior management
any trading practices that might violate this Code
• Establish clear lines of accountability for the company’s
power trading practices with appropriate oversight by the
Board of Directors or other senior corporate management
committee
Committee of Chief Risk
Officers Best Practices Papers
Governance—separation of functions
Valuation and risk metrics
Credit risk
Disclosure
Will the Industry Response be
Sufficient?
Self policing a necessary first step
Shrinkage gas/electricity trading volumes a reality
but bottom may be near
Deferred and cancelled plants starting to be a
concern and gain policy attention
A more conservative approach to economic
fundamentals and reporting is here to stay
Less out right sale of assets—more debtor in
possession
John J. Stauffacher
Consultant to the Energy Industry
Contact information:
Phone- 281-438-1400
Cell- 713-299-5766
e-mail [email protected]