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 costsPart 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 marketExisting 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 investmentPrices for divested generation escalatedReality of slow demand, over supply and resultant lower electric prices

Year Avg Sale Price X Book2000 $430/kw 1.82001 618 1.7

2002(10 mon) 305 1.7

Financing the industry- can 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

0

20

40

60

80

100

120

140

2000 2002

upgrade

down-grade

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 MarketsA “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 facilityUnder resourced load pockets exist—despite NERC’s rosy forecasts—24% reserve margin by 2005But, 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 proponentsStrange 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 usedTechnical argumentsRegional argumentsEconomic 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 stepShrinkage gas/electricity trading volumes a reality but bottom may be nearDeferred and cancelled plants starting to be a concern and gain policy attentionA more conservative approach to economic fundamentals and reporting is here to stayLess 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 JStauf@AOL.com