PUHCA still stifling industry growth

Power, Jun 1, 2005 by Peltier, --Dr Robert

When is a merger really not a merger? Last month a Securities and Exchange Commission (SEC) Administrative Law judge ruled that the 2000 merger of American Electric Power (AEP) and Central and Southwest Corp. (CSW) violated the Public Utility Holding Company Act (PUHCA). He reasoned that the merged companies did not constitute a "single, integrated public-utility system" because CSW's operations bordered Mexico, whereas AEP's bordered Canada.

"This decision disappoints us, but it does not alter AEP's current structure or operations," said Michael G. Morris, AEP's chairman, president, and CEO. "We have been operating as a single integrated company for almost five years now, so this appears to be an instance where legal theory doesn't conform to reality." Amen to that.

New era, new needs

PUHCA was passed to regulate utility holding companies after a number of Enron-like firms had made speculative investments with ratepayers' money and used accounting schemes to avoid state regulation. These abuses spawned federal legislation that empowered the newly formed SEC to block mergers, some of which had created large utility cartels during the 1920s. By 1932, three holding companies controlled almost half of the U.S. investor-owned utility (IOU) industry, and eight controlled almost 75% of it. PUHCA, enacted in 1935, dissolved the holding company structure of utilities with noncontiguous service territories and made proposed mergers subject to regulatory approval. By 1958 the number of holding companies had decreased from 216 to 18.

Today, most industry observers believe that utility mergers are necessary (the "bigger is better" theory) and will become more common. Industry consolidation is expected to continue at a breakneck pace over the next few years. In fact, according to Gary Hunt, president of Global Energy Advisors, "Expect 50% consolidation over the next five years." He sees two forces driving the trend. One is that "the next round of generation is already on the ground." The other is that IOUs' other opportunities for growth are limited to increasing the size of their ratebase and securing fuel supplies by, for example, building liquefied natural gas-receiving facilities.

With the U.S. DOE projecting 1.8% annual electricity demand growth over the next 25 years, you need not be a rocket scientist to understand that if yearly earnings growth of 6% to 8% is needed to attract Wall Street's attention, a merger or an acquisition is the only way to go. However, PUHCA may be the trump card that causes the proposed merger of Cinergy and Duke to fold, because they are untethered by transmission lines.

Next stop, Congress

IOUs and other groups--including the SEC--have long been lobbying to have PUHCA repealed, claiming that the law is an anachronism that limits badly needed investments in energy infrastructure. PUHCA repeal has been included in nearly every comprehensive energy bill that Congress has failed to pass in recent years. However, the bill currently marking time in the Senate Energy and Natural Resources Committee does not call for repealing PUHCA. Yet a committee spokesperson admits that the AEP-CSW decision and the proposed Duke-Cinergy merger have "increased pressure" to include such a provision.

Senate Democrats have insisted that repeal of PUHCA be accompanied by a provision to beef up the review of mergers by the Federal Energy Regulatory Commission (FERC). Reports are that all committee Republicans save one have agreed to couple PUHCA repeal with giving FERC more merger oversight. No provision to repeal PUHCA or to give FERC more authority is in the House version of the energy bill.

Although nearly all utilities and federal regulators support the repeal of PUHCA, the law remains on the books. Industry insiders say the proposed Duke-Cinergy merger poses an ideal argument for getting rid of PUHCA, for this reason: It allows only mergers of contiguous utilities, which could lead to near-monopoly ownership of generation in a large region. FERC has been fighting against this outcome by applying market-power tests to proposed mergers.

In my mind, the case for PUHCA repeal can be reduced to fairly simple terms. Wall Street is telling IOUs that if they want investments, they must make decent returns. Turning a profit in today's stagnant market requires economies of scale, and bigger is indeed better in that regard.

But size isn't all that matters. I think such arranged marriages only work if the two parties share a common culture and complement each other in diversity of fuel supply and generation assets. A merger or acquisition shouldn't be a mere target of opportunity for any utility truly committed to public service. But whether or not FERC ends up having more say on the matter, one thing is clear: In today's uncertain electric power environment, U.S. energy infrastructure needs fewer barriers to investment. For that reason alone, the 70-year-old PUHCA should be scrapped because it's pass.