Cash-strapped utilities could find themselves embarking on an unexpected spending spree.
Following last week's massive blackout, the nation's indebted utilities are fielding calls for new investments even as they struggle to pay off old ones. Specifically, they are hearing loud demands for transmission upgrades that offer smaller returns than those once promised -- but never fully realized -- in the power generation field.
Under better circumstances, utilities could actually eyeball the transmission business as a decent opportunity. After all, transmission generates the guaranteed returns now favored by the ratings agencies and by shellshocked investors who have come to shun the riskier, and sometimes unprofitable, deregulated energy businesses. Moreover, pending legislation promises to sweeten the pot for businesses that post the capital needed to upgrade the nation's vulnerable transmission system.
But proposed incentives don't always become law. And in the meantime, utilities have already thrown too much cash -- a lot of it borrowed -- at failed opportunities elsewhere.
"The utilities across the United States have spent very little on system upgrades," said Karl Miller, an industry insider at Miller McConville Christen Hutchison & Waffel. "It will be expensive."
Right now, many utilities are racing to pay down debt -- and curtail new investments -- just to keep their credit ratings intact. But the recent power outage, which left some 50 million people without electricity for up to two days, has triggered outcry from political leaders who have the authority to push for costly infrastructure upgrades.
So far, most utilities have shown a clear reluctance to invest heavily in transmission systems or -- as recommended by the Federal Energy Regulatory Commission -- sell them to independent companies that will. Instead, the utilities have clung to their old transmission systems, controlling access to competitors, as they wait for new incentives that make system upgrades look more worthwhile. But the blackout of 2003 may have pulled the plug on that strategy.
"The U.S. needs significant energy infrastructure investment to avoid future disruptions in energy delivery," wrote Williams Capital analyst Christopher Ellinghaus. "The blackout is likely to result in great political outcry and
some regulatory response."
Dot Matthews, the senior utility analyst at CreditSights, embraces pending legislation that would overhaul the nation's "medieval" transmission system. She calls such measures "good for the industry and good for the country." But she also admits that some weaker utilities could suffer along the way.
the legislation would be a very good thing," Matthews said. "We need to rationalize the electrical system. But short term, I don't know. There could be costs and adverse consequences for some."
First in Line
Right now, perhaps no utility seems quite as vulnerable as
By the time the lights came back on in FirstEnergy's home state of Ohio -- and Cleveland finally regained access to its water supply -- critics were already pointing fingers at the embattled utility. FirstEnergy stood accused of failing to report early problems with three of its transmission lines and a nuclear reactor. The company, which later admitted that its internal alarm system had also malfunctioned, nevertheless insists that the blackout was not its fault alone. And for its part, the North American Electric Reliability Council has so far referred to the accusations against FirstEnergy as premature.
But the ratings agencies have proven less generous. Admittedly, Moody's began scrutinizing FirstEnergy just hours before the blackout by sheer coincidence. But Standard & Poor's -- which rates some FirstEnergy credit just above junk -- placed the company under review as a direct result of the outage.
"To the extent that any culpability is ultimately determined to rest with FirstEnergy, the financial consequences of such a conclusion will weigh heavily on a potential Standard & Poor's rating action," S&P credit analyst Aneesh Prabhu wrote late Monday. "The CreditWatch also reflects the possibility of additional investment in capital expenditures not factored in the company's current rating."
Bernstein stock analyst Hugh Wynne has projected that FirstEnergy could wind up spending $125 million annually -- or about triple its original plans -- on transmission upgrades over the next three years. Without issuing up to $1 billion of new equity this fall, he says, FirstEnergy's financial condition will be "insufficient to maintain its investment-grade rating."
Although Wynne expressed confidence that FirstEnergy could raise the fresh capital, other analysts have voiced some concerns.
"FirstEnergy's involvement in the blackout could impact the price or ability to issue equity and could also further impact the credit agencies' view," Merrill Lynch analyst Steven Fleishman wrote just ahead of S&P's own warning.
A cut to junk, still viewed as unlikely by most, would hike FirstEnergy's borrowing costs at a time when the company is struggling to pay down debt accumulated through an acquisition binge carried out in recent years. Since 1996 -- when deregulation made the power industry look like a new frontier -- the original Ohio Edison has twice doubled its size by snatching up other utilities that nobody else seemed to want. Two of the biggest acquisitions brought nuclear power plants that have hardly helped the bottom line. The first, a nuclear power station in Ohio, has been sitting idle since federal authorities learned of a serious acid leak there early last year. The second, a mothballed unit at the infamous Three Mile Island in Pennsylvania, remains inactive to this day.
But until early this month, when FirstEnergy warned that it had overstated past earnings, investors were willing to view the company as a success. The stock, which hit an all-time peak of $38.90 in late June, has since plummeted over concerns tied to the recent blackout. The shares regained 21 cents to hit $27.96 in heavy trading Tuesday.
At some utilities, however, the blackout could actually mean brighter days.
The stronger ones, with funds to spare, may very well leap at the opportunity to invest in transmission upgrades if new incentives come through. And other players, who either can't or won't invest in the business, can sell their transmission lines to independents and use the proceeds to clean up their balance sheets.
Some cash-starved utilities, particularly in the deregulated market of Michigan, have already pursued such divestures in an effort to pay down debt. Other big utilities, including neighboring
American Electric Power
-- which co-owns a transmission line with FirstEnergy -- and
, have expressed a willingness to sell transmission assets if favorable legislation such as a capital gains tax break comes through. But for now, utilities continue to control the bulk of a national transmission system that's badly in need of repair.
While the industry as a whole continues to cling to those assets, independents such as Trans-Elect -- and even government authorities -- have called for a separation of powers.
"The dysfunctional transmission system ... is in desperate need of major capital investment and a clear federal mandate to force monopoly utilities to transfer the ownership and operation of their transmission systems to nonconflicted, independent and credible management," Miller said.
But Ellinghaus, for one, stops well short of blaming utilities for the massive blackout and other transmission problems. He insists that utilities would have been happy to invest in transmission -- instead of throwing all their money at power plants -- if they could clear the regulatory hurdles and investment returns they needed.
Matthews offers a similar view. She agrees that utilities have seen no economic or political reason to upgrade their transmission systems. But she holds out hope that the situation will finally improve.
"You have to have a system," Matthews said. "We don't have that in the United States. ... We have little fiefdoms everywhere."
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