Energy Firms Seek to Share
Pain With Utility Subsidiaries
Weakened Regulators Have Little Power to Stop
Parent Companies From Milking Healthy Units
By REBECCA SMITH
Staff Reporter of THE WALL STREET JOURNAL
Energy companies, burned by disastrous forays into commodities trading and
other unregulated businesses, are increasingly seeking to pass some of the
financial burden on to their utility units, and some experts are worried that this
could lead to higher electricity rates for consumers in coming years.
Utilities, the boring-but-steady companies that provide electricity to homes and
businesses, are among the few players to have survived the meltdown of the
nation's $200 billion energy sector largely unscathed. Many of the utilities' parent
companies would like to take advantage of these units' relative financial health to
prop up other, troubled subsidiaries. Utilities are being nudged to buy assets from
affiliates, make loans to down-at-the-heel siblings or pass more money to their
parent companies.
The industry's plunging fortunes, symbolized by the collapse into bankruptcy of
Enron Corp. last year, sparked new vigilance on the part of regulators, who are
jumping on some of these questionable activities. Duke Energy Corp. recently
agreed to pay $25 million to its utility customers to settle regulators' accusations
that the company improperly stuck its utilities with expenses that rightfully
belonged to unregulated affiliates. Duke, of Charlotte, N.C., didn't admit to any
wrongdoing.
Regulators Hampered
In many cases, though, regulators can do little to prevent energy holding
companies from milking their utility units. As deregulation swept the nation in the
late 1990s, state legislatures often clipped the wings of regulatory commissions
to save money and give emerging markets more breathing room. The
commissions were left understaffed. With little or no authority to review the
books and records of the unregulated businesses, they now only see part of the
picture.
"The sector has totally hit the wall," says Michael Valocchi, head of the utility
practice at IBM Consulting Services in Philadelphia. "And now utilities are being
expected to make up for losses on the unregulated side." Mr. Valocchi says his
utility clients tell him they are under orders to cut capital spending by as much as
30% in 2003, in some cases to free up funds that can be passed to holding
company parents.
These companies' needs are great. In the third quarter alone, problems at the
unregulated units of AES Corp., Allegheny Energy Inc., Aquila Inc., Dynegy
Inc., TXU Corp., Westar Energy Inc. and Xcel Energy Inc. wiped out more than
$14 billion of balance-sheet capital through losses and charges. Moreover, the
sector built up huge debts from its expansion in the 1990s into such businesses
as telecommunications, power generation and, in one case, a home-security
company. More than $25 billion of debt must be repaid industrywide next year.
Credit-rating agencies, recognizing that utilities are vulnerable to their parents'
woes, have cut debt ratings for these subsidiaries, along with slashing the ratings
on the parent companies. More than two dozen utilities covered by rating agency
Fitch are rated at junk status, making it difficult and costly to refinance debt. For
the time being, higher financing costs will mostly be borne by holding company
shareholders. But analysts say it is likely that utilities eventually will argue to
regulators that their higher cost of capital warrants increases in the rates they
charge electricity customers.
Reducing Spending
Some utilities have responded to the added financial burdens by reducing
spending on new equipment and routine maintenance, moves that could impair
service and safety. In the early 1990s, California's Pacific Gas & Electric Co., a
unit of PG&E Corp., reduced its tree-trimming and maintenance expenditures. The result: Winter storms in 1995 toppled rotten power
poles and felled overgrown trees onto transmission lines, causing record power outages in Northern California. Storm-related outages in
the state this month appear likely to trigger an investigation, even though the utility says it hasn't scrimped on spending since seeking
bankruptcy protection a year and a half ago.
Regulated utilities achieved their modern form by the late 1920s, when laws gave them monopoly territories in exchange for an
obligation to provide safe and reliable service. A 1935 federal law set restrictions on how much cash parent holding companies could
suck out of utility units. But by the late 1990s, state and federal governments were chipping away at such legal limitations and wholesale
and retail power markets were being opened to competition. Holding companies got opportunities to branch into new, unfettered
businesses. Regulators assumed that if things went awry on the unregulated side, utilities would be shielded from those losses. But that
isn't the way it is working out.
Kansas Reins In Westar
Consider the case of Westar Energy of Topeka, Kan. Last month, the Kansas Corporation Commission, the state's utility regulator, took
the unusual step of ordering the company not to cause harm to its two Kansas utilities, Kansas Gas & Electric and Kansas Power &
Light. The directive came after regulators found that Westar had quietly shifted more than $1.95 billion of debt onto the utility side of
the business, by arranging intercompany loans and other means. The commission says it wants complete legal and financial separation
of Westar's utilities from the rest of its enterprises, and especially from Protection One Inc. That Westar unit, a home-security firm,
contributed $1.03 billion in losses and charges to Westar's bottom line from 1997 through this year's third quarter.
Commission Chairman John Wine says utility holding companies "can go pretty far down the road of commingling utility assets before it
gets detected." He says he is worried about the eventual impact on utility service and rates.
Other energy holding companies are relying on their utilities for help more openly than Westar. Cincinnati-based Cinergy Inc. in
mid-December got regulatory approval to transfer two power plants from an unregulated unit, Cinergy Capital & Trading, to its utility,
Public Service of Indiana, for more than book value of about $500 million. Similarly, Pinnacle West Capital Corp., of Phoenix, is seeking
permission to borrow as much as $500 million from its regulated utility, Arizona Public Service, or to get the utility to back such a loan.
It has gotten the go-ahead from state regulators to borrow $125 million so far. Both companies in recent years built up
energy-generation and trading units that haven't developed as expected.
One of the clearest examples of a lack of firewalls between utilities and unregulated affiliates came at Duke Energy. In July 2001, a
Duke accountant contacted regulators to complain that expenses generated by unregulated parts of the company were being transferred
to the books of Duke's utilities. Regulators in North Carolina and South Carolina, where the utility units operate, hired Boston-based
Grant Thornton LLC to conduct an audit. In October, the auditors concluded that Duke, which has become a large energy trader, had
wrongly accounted for $124 million in expenses.
E-mail messages showed a protracted campaign by Duke accountants to shift expenses onto the utilities, according to the audit. The
actions artificially depressed earnings at Duke's utilities. Grant Thornton suggested this had the effect of reducing the possibility that the
utilities might earn more than their permitted rates of return. Excess earnings could have prompted regulators to order the utilities to
make refunds to customers. They also could have moved to cut Duke's allowed rates of return from about 12% currently. Duke
contested the audit, but agreed to pay $25 million to its utility customers to end the investigation without admitting wrongdoing.
'Settling Cheap'
Regulators might have overlooked the events at Duke if not for the inside tip. Neither of Duke's utilities has been subjected to a full
regulatory review in more than a decade. Mignon Clyburn, chairwoman of the South Carolina Public Service Commission, says her
agency has been criticized for "settling cheap" but complains, "we have no stick." Her agency employs just 80 people and has no fining
authority.
Industry experts say such juggling of expenses by energy companies is occurring with greater frequency and often goes undetected by
state regulators except when audits are conducted as part of rate cases. But rate reviews have become more sporadic in recent years.
Like all public companies, energy concerns must file audited financial reports with the Securities and Exchange Commission. But the
SEC doesn't check whether expenses are being shifted between regulated and unregulated units.
Many regulatory commissions are looking for ways to strengthen their oversight powers. A few states, including Oregon, Wisconsin,
Virginia and New York, restrict the ability of holding companies to siphon money out of their regulated units. Wisconsin sets minimum
capital requirements for its utilities, and requires rates and utility operations to be reviewed at regular intervals.
Still, a lack of manpower limits regulatory commissions from enforcing even tougher rules. Oregon, for instance, found this year that
Enron, which bought Portland General Electric Co. in 1997, took $27 million out of the utility two years ago to which it wasn't entitled.
Getting that money back now that Enron is under bankruptcy-court protection will be difficult, officials say.
"If we're one of the better states, that's a scary proposition for the nation," says Bob Jenks, head of the Oregon Citizens Utility Board, a
Portland consumer group. "Things aren't really under control here." |
