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Integrated ElectricsIntegrated ElectricsTwo Steps Forward…One Step BackTwo Steps Forward…One Step Back
Scott PearlScott PearlIntegrated Utility AnalystIntegrated Utility Analyst
The Institute for Regulatory Policy Studies’ The Institute for Regulatory Policy Studies’ Energy Markets at the CrossroadsEnergy Markets at the Crossroads
December 12, 2002December 12, 2002
The Old Model Served Customers Well Since the Great Depression
Raw Materials
(Coal, Oil, Gas, Uranium, Water)
MANUFACTURING
DELIVERY
Franchise Customers
BTU
MWH
Industry Structure• Vertically integrated • Monopoly supplier• State regulation• Obligation to serve /
regulatory compact
2
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
Average Real Electric Price (1996 $'s) Average Nominal Electric Price
But Rising Prices Inspired Federal Regulators to Act
Source: EIA and CSFB estimates
3
PURPA (1978)
NEPA (1992)
Order 888 (1996)
SMD (2002)
Oil Crisis (1973)
Ce
nts
/kW
h
Average U.S. Retail Electric Rates
And It All Seemed To Be Progressing Smoothly
• 23 states enacted electric restructuring legislation between 1996 and 2000
• California developed the first U.S. wholesale power exchange in 1998
Source: EIA and CSFB estimates 4
No Retail Competition Retail Competition
Legend
Until the California Crisis Exposed…
5Source: Bloomberg and CSFB estimates.
Prices for Electricity and Natural Gas
(1/1/99 – 06/30/01)
$0
$100
$200
$300
$400
$500
$600
Palo
Ve
rde
$/M
WH
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
He
nry
Hu
b $
/MM
BT
U
Palo Verde Henry Hub
0%
5%
10%
15%
20%
25%
30%
1996 1997 1998 1999 2000 2001 2002E 2003E 2004E 2005E 2006E 2007E
The Magnitude of Boom and Bust
6Source: RDI, EIA, NERC, CSFB estimates
US Reserve Margin(1996 – 2007E)
UNDER-SUPPLY
OVER-SUPPLY
The Dangers of Too Much Leverage
• Business and financial risks must be properly aligned
• < 50% debt for manufacturing, lower for risk management
• Lack of tenor matching exposed liquidity concerns
• Financial engineering can be life threatening – ratings triggers
Source: Factset, CSFB estimates. 7
26%
45%
51% 53%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
E&P Steel Paper Chemicals
Debt-to-Capital Ratios for Other Commodity Manufacturers
Source: Factset, CSFB estimates.
Debt / Capitalization Ratio – Integrated Electrics
(1992-2001)
48%
50%
52%
54%
56%
58%
60%
62%
64%
66%
And The Fragility of Investor ConfidenceS&P Utility Index5/1/2001 to Present
8
35
45
55
65
75
85
95
105
July 2001Barrons Article on
Power Glut
December 2001 Enron Bankruptcy
March 2002Dynegy annouces SEC Investigation
for wash trades
May 2002Enron memo
surfaces in FERC investigation
June 2002WorldCom
October 2002TXU reveals liquidity
crisis owing to UK market weakness
September 2002Need for
additional equity by Dominion and TECO touch off a wave of liquidity
concerns
Causing a Re-Examination of The Entire Approach
• Two steps forward, one step back
• 9 of 23 states are re-evaluating retail deregulation (California suspended)
• All eyes on Texas deregulation experiment
Source: EIA and CSFB estimates 9
Status of Retail Deregulation By State
Restructuring Delayed Restructuring Suspended Restructuring Not Active
Legend
Restructuring Active
0
5
10
15
20
25
30
35
40
45
50
Apr-90 Apr-91 Apr-92 Apr-93 Apr-94 Apr-95 Apr-96 Apr-97 Apr-98 Apr-99 Apr-00 Apr-01 Apr-02
Pool
and
GTM
A m
arke
t pric
e (£
/ M
Wh)
Pool purchase price NETA Pool Market Mechanism Trend NETA Trend
Pool Market Mechanism NETA
…But If Structured Properly, Deregulation Can Benefit Ratepayers
UK Power Pool Prices12/1988 to 12/2002
10
Australian Power Prices1/1999 to 12/2002
0
20
40
60
80
100
120
140
Jan-99 Aug-99 Feb-00 Aug-00 Feb-01 Sep-01 Mar-02 Sep-02
$/M
Wh
(AU
)
South Australia Queensland South Australia Trend Queensland Trend
• UK prices have declined substantially in response to improved market design
We Envision A Disaggregated World
Manufacturing
• Commodity conversion
• Location, location, location
• New technology, improved
operating efficiency
• Lessons from: E&P, steel,
refiners, paper, chemicals
Risk Management
• Energy intermediaries (retail
and wholesale)
• Intellectual capital /
information nexis
• Strong balance sheet
• Lessons from financial
services/brokerages
Delivery
• Regulated infrastructure
• Regulators drive returns on
capital
• Incentive regulation can
encourage efficiency
• Lessons from UK regional
electrics/transmission
companies
M ANUFACTURING
IPPsGeneration-
FocusedUtilities
EnergyMerchants
IntegratedE lectrics
RISKM ANAGEM ENT
DELIVERY
RAWM ATERIALS
ENDCONSUM ER
11
20,000
25,000
30,000
35,000
40,000
45,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Hour
MW
0
50
100
150
200
250
300
350
400
450
500
$ p
er M
WH
Actual load NP15 Price
With Differentiated Opportunities to Create Value
• Substantial value to be captured through evolution to competitive market – Improve resource allocation decisions and operating efficiency
• Average US Electric Rate - ~ 70% Generation - Cost of New CCGT
~ $72 / MWh~ $50 / MWh~ $45 / MWh
$5 / MWh * 3.9 BN MWh/Yr = $20 BN / YR
Risk Management
• Smooth volatility
Manufacturing
• Improved utilization
Delivery
• Infrastructure Investment
Source: SNL Securities Database and CSFB estimates. Source: California ISO and CSFB estimates. Source: Beacon Energy and CSFB estimates.
12
Nuclear Capacity Factor (1991 –2001) 24 Load & Price – CAISO (7/27/00) Transmission Investment vs Demand
650
670
690
710
730
750
770
790
810
830
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Su
mmer
Peak
Dem
and (
GW)
155
160
165
170
175
180
185
190
195
200
205
Tran
smiss
ion M
iles (
000s
), (23
0 kV
and a
bove
)
60%
65%
70%
75%
80%
85%
90%
95%
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
• P/E ratios diverged as competitors pursued strategies focused on different aspects of the energy value chain
• Commodity cycle conditions have increased P/E volatility for unregulated players
13
One Year Forward P/E Ratios for Electric/Gas Companies
(1/1/96 to Present)
Source: Factset and CSFB estimates.
And The Markets Are Reaching a Similar Conclusion
0x
5x
10x
15x
20x
25x
30x
35x
40x
1/02/96 7/09/96 1/14/97 7/22/97 1/28/98 8/05/98 2/11/99 8/19/99 2/25/00 8/31/00 3/12/01 9/21/01 03/29/02 09/30/02
1 Y
R F
WD
P/E
IPPs (Manufacturing) Energy Merchants (Risk Management) Integrateds (Delivery)
As Always, the Devil Will Be in The Details
• Near term (managed monopolies)
Generation price caps
Limit market concentration
Mandated reserve margins
Standardized market design
• Long term (free market for generation)
Sufficient investment in transmission grid
Floating retail generation rates / end of stranded cost recoveries
Incentive rate structures for delivery
Emergence of new technology
14
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