A.

Joseph Cavicchi is a Vice

President at Lexecon, an FTI
company based in Cambridge,
Massachusetts, where he provides
wholesale and retail electricity
market regulatory economic analyses
in connection with the restructuring
of the U.S. electricity industry. In Electricity Company Affiliate
particular, he advises clients in a
variety of Federal Energy Regulatory Asset Transfer and Self-Build
Commission and state regulatory
proceedings related to the new Policies: Renewed Regulatory
markets and the contractual
arrangements that have emerged to Challenges
support the electricity industry. Prior
to joining Lexecon, he was a staff
mechanical engineer and project Wholesale market conditions are leading to a spate of
manager at the Massachusetts
Institute of Technology. He holds an requests that generation assets built and/or owned by
S.M. in Technology Policy from MIT unregulated affiliates be acquired or contracted out to
and an S.M. in Environmental
Engineering from Tufts University
affiliate utility companies. They may call for a level of
(jcavicchi@lexecon.com). independent analytical review that is completely severed
Scott T. Jones is Senior Managing
from the applicant utility.
Director and head of Lexecon’s
energy practice, with more than 30 A. Joseph Cavicchi and Scott T. Jones
years of industry and consulting
experience. As a consultant, Dr.
Jones has coordinated projects for
electric utility, oil and gas,
petrochemical and other energy I. Introduction generation facilities for their
industry clients. As a senior customers. These purchase and/
executive with major energy Concurrent with the emergence or build proposals have collided
companies, he was responsible for
of a glut of excess generation with wholesale competitors
marketing, trading, production,
business development, and all capacity has been an effort by striving (often unsuccessfully) to
regulatory matters. Dr. Jones’s recent utilities with obligations to serve sell their plant output to those
work includes valuation and damages consumers to roll so-called same utilities proposing to buy
testimony, strategic business asset distressed generation assets into from affiliates and/or build new
development, and the application of ratebase, including, in many supplies. At first glance it appears
public policy to regulated and
instances, facilities built by that utilities would prefer not to
unregulated energy industry issues.
unregulated affiliates. At the turn to the wholesale market to
He holds a Ph.D. in Economics from
Virginia Tech. same time, utilities in some parts purchase electricity supplies, but
of the U.S. are arguing in instead use it only as a means for
regulatory proceedings that they selling their own excess supplies.
should once again be building Even though there are various

November 2004 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003 29
 compelling arguments that can be
made in support of these recent
affiliate transactions and
self-build proposals, it would be
imprudent to accept these
outcomes without carefully
considering the facts and
circumstances surrounding each
proposal. Regulators ought to
exercise great care when
reviewing the large number of
these long-lived transactions
currently in process, as their
long-term impact may be harmful
to both ratepayers and the
vibrancy of the wholesale
electricity market.
T he infrequency, magnitude,
technical complexity, and
potential impact on the
competitive market appropriately
requires that these proposed
transactions comply with various
state and federal regulatory
reviews. Currently, several state
regulators have approved these
transactions, largely based on cost
criteria developed using models
with 20- to 30-year horizons. The
projected benefits estimated in the
analyses usually come much later
in the life of the facility, during
uncertain distant years and well
beyond the reach of any existing
method for hedging the risk of
forecast error. In most cases these
analyses contain little or no
emphasis on potential impacts to
the wholesale market. State and
federal regulators must work in
concert to ensure a consistent and
thorough review of these
important transactions.
In this article we present a
qualitative review of several
affiliate asset transfer requests,
30 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
proposed affiliate purchase
power agreements, and self-build
proposals. We first present
taxonomy of proposed and
recently completed transactions.
We then describe the most salient
aspects of the state and federal
regulatory review process.
Thereafter we examine three
particular issues that often emerge
during the regulatory review of
these transactions: longevity,
potential self-dealing associated
Several state regulators
have approved these
transactions, largely
based on cost criteria
developed using models
with 20- to 30-year
horizons.
with vertically integrated
applicants, and credit or debt
impacts. We conclude that these
infrequent transactions are
detailed, complex, and rely on
speculative long-term analyses
rendering the assurance of
long-run benefits uncertain. Thus,
we recommend that regulators
(especially at the state level)
scrutinize the transactions using an
independent analytical review
process; that is, a review that does
not rely exclusively on the utilities’
own internal analyses verified by
independent monitors, but instead
relies on the findings of an
independent analytical team
charged with fairly evaluating all
competing supply options
available to the utility.
II. Transactions to Date
and the Regulatory
Review Process
Table 1 provides a listing of
electricity companies that are
currently engaged in regulatory
proceedings, or that have recently
completed and received
regulatory approval, for
transactions that involve either
contract purchase of power or
generation plants from affiliates,
or the pursuit of self-build
options. Although there are
numerous specific details
associated with each of these
transactions, they each have in
common the fact that there is, or
was, considerable debate that
ensued following the revelation of
the proposed transaction. Setting
aside in-depth interpretations of
the facts surrounding each of the
proposals, it is slightly alarming
that almost all the proposals are
allowing regulated entities to
assume ownership of assets that
are currently facing challenging
market environments.
N ot surprisingly this
trend toward affiliate
transactions began in earnest in
2002. At this time, forward
electricity prices had dropped
partially in response to the
quantity of new capacity that was
brought on line. By the end of
2001, it was clear that some
200 GW of new generating
capacity was going to be
constructed as a result of the
The Electricity Journal
November 2004

Table 1: Recent and On-Going Power Procurement Efforts Involving Affiliate Transactions and Self-Build Options
Proposal and Process Details
Holding Company Utility Unregulated Affiliate Proposal/Status RFP Independent Monitor
Ameren Union Electric Company Ameren Energy Generating Co. 2/5/03 Section FPA 203 10–25 years; although, Yes, Burns &
Corporation d/b/a Ameren UE (AEG) & Ameren Energy request to allow AEG to 10 years used for RFP, McDonnell.
Marketing Co. (AEM) transfer-sell Pinckneyville but 25 years for FERC filing.
(316 MW) & Kinmundy
1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003

(232 MW) to Ameren UE

at net book $161.5 B
and $96.4 M, respectively.
Approved by Missouri PSC
and FERC.
Cinergy Corp PSI Energy, Inc. CinCap Madison, 9/6/02 Section FPA 203 request to No; Integrated Resource N/A
LLC & CinCap VII, LLC allow transfer/sale of Madison Plan presented to Indiana PSC.
(576 MW) and Henry County Gen.
Station (136 MW) to PSI at net book
of not more than $450 M. Approved
by Indiana PSC and FERC.
Pinnacle West Arizona Public Pinnacle West Energy Spring 2003 Arizona rate case filing None with respect to request, No
Capital Group Service (APS) (PWEC) by APS requesting approval to transfer although a RFP was carried
PWEC assets into APS ratebase at book out during proceeding.
value. PENDING.
PacifiCorp Utah Power N/A–PacifiCorp will build Utah PSC approved PacifiCorp’s Currant Yes; PacifiCorp selected its Yes, Navigant
Currant Creek Power Project Creek self-build option 3/5/04. own ‘‘next best alternative," Consulting.
although the RFP process
was disputed as next best
alternative was modified
during process.
N/A Southern California N/A Mountainview Power Co. sold its No N/A
Edison (SCE) yet-to-be completed 1,054 MW
electricity plant to SCE. Approved
by California PUC and FERC.
31
 Independent Monitor
boom that started in 1998 and

Yes, Lexecon.
1999. Market participants
recognized that a significant
amount of excess capacity was
No

emerging, reducing activity in the

forward market in response to an
(600 MW) were winners.

expected softening of spot

non-affiliate resources
electricity prices.1 Around this
(1,240 MW) & Duke

Yes; Both affiliate and

Yes; Southern Power

time, many regulated utilities (not

RFP

selected. facing retail competition) began

shopping for future generation
supplies. To support their
acquisition efforts, buyers relied
on state regulatory frameworks
were sold to IOUs following Georgia PSC approval.

meant to encourage new

at FERC and approved by Georgia PSC. Proposal

generation capacity through a

subsequently withdrawn at FERC and units

least-cost review process.

and 11 (1,240 MW) and utilities proposed
Initially PPAs between McIntosh Units 10

A t the state level, the

procurement/approval
Proposal/Status
Proposal and Process Details

review at the FERC. PENDING.

process focuses on the provision

of generation capacity to meet
EWO and Services under

peak demand. A common

Proposed PPAs between

denominator in the process is a

cooperative effort where the uti-
lity establishes a need for added
capacity—usually through
integrated resource plans—that is
then undisputed (or even
enhanced) by regulators. Once an
EWO Marketing, LP
Unregulated Affiliate

applicant establishes need

Southern Power

pursuant to state regulatory

requirements, the issue then
becomes how to solicit additional
energy and capacity, and the
technique that should be used to
Electric and Power

Entergy Operating

analyze the expected cost of new

Inc. on behalf of
Entergy Services,
and Savannah

supplies. State regulatory

Georgia Power

Companies
Utility

procurement guidelines typically

require the utility to solicit
Table 1: (continued).

generation supply proposals from

the wholesale market. Table 1
reveals that requests for proposal
Holding Company

(RFPs) were issued in the case of

Corporation
Company

AmerenUE, Arizona Public

Southern

Entergy

Service (APS), Utah Power,

Georgia Power, Savannah

32 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003 The Electricity Journal
 Electric, and Power and Entergy
Services, Inc. In some cases,
unregulated generation affiliates
make offers as part of the RFP
process: Southern Power for
Georgia and Savannah Power,
and EWO Marketing for Entergy.
In some cases, the affiliate does
not make an offer (Pinnacle West
Energy, or PWEC, in the case of
APS2) or the RFP respondents’
offers are compared to self-build
next-best alternatives (Pacifi-
Corp’s Utah Power proposal).
Finally, in one instance the
proposed asset transfer price was
compared with the results of a
previously conducted RFP
(AmerenUE).
A n alternative to the RFP
process, whether it is from
an affiliate or other market
participants, is to propose to the
state regulatory commission that
affiliated assets be rate-based.
Support for this approach
becomes part of a hearing or other
review process (examples are APS
and PSI Energy). Regardless of
how the utility manages its
procurement, at the core of the
review is an analytical process
that searches for the least-cost
alternative to providing
ratepayers with reliable,
environmentally friendly future
electricity supplies.
While the states tend to focus
on determining the most suitable,
lowest-cost supply option
proposed by the utility, FERC
focuses its review on the
proposal’s impact to competition,
rates, and ability to regulate.3 In
particular, FERC looks carefully
at vertical and horizontal market
November 2004 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
power impacts of a proposed
transaction. Currently, FERC uses
two frameworks for reviewing
these transactions. One calls for
careful analysis of any proposed
transaction that involves an
unregulated affiliate and a
regulated affiliate. The second
requires that proposed
transactions be ‘‘screened’’ to
assess whether the competitive
marketplace will be harmed as a
result of the transaction.
An alternative
to the RFP is to
propose to the state
regulatory commission
that affiliated
assets be
rate-based.
With respect to the review of
proposed affiliate deals, FERC has
recently articulated in its
Mountainview Power Order4 that
any future affiliate transactions
will be subjected to its so-called
Edgar test, which is meant to
ensure that affiliates were not
favored during the supply
purchase decision-making
process. The Edgar review
process is specifically focused on
determining if there is any
evidence of self-dealing by
establishing various review
standards against which affiliate
transactions are compared to
ensure no undue favoritism
occurred.5 FERC has also recently
provided additional guidance in
its Opinion No. 473 stating
that affiliate transactions which
result from a formalized RFP
process that complies with
various guidelines will increase
the likelihood of FERC approving
a proposed transaction quickly.6
The recent increase in affiliate
transactions has resulted in
heightened awareness at FERC.
T he second review process is
required when an
acquisition or merger is
proposed.7 The review focuses on
assessing if a transaction will
increase an applicant’s ability to
exercise market power by
screening for potential impacts of
the transaction on the wholesale
marketplace. If a transaction
appreciably increases supply
under an applicant’s control, it is
likely that the screens will be
violated indicating that an
applicant’s ability to exercise
market power may be enhanced.
Screen failures typically require
applicants to propose remedies
that usually must eliminate the
screen failures.8
Beyond those regulatory
reviews that are required for a
proposed transaction, if state
regulators allow a regulated
utility to construct new
generation facilities that do not
require explicit federal reviews,
FERC’s procedures for evaluating
market-based ratemaking
authorization requests can impact
the proposal. If these tests reveal
that an increased concentration in
generation ownership has
resulted from the construction of
a new plant, the result can be a
33
 finding that the utility could
exercise market power.9 In this
instance, aside from identifying a
structural solution to the problem
such as relinquishing control of
some capacity, the only simple
available alternative an applicant
has to resolve FERC concerns is to
file a cost-based tariff for the
facility.
U nlike FERC, state
regulators do not delve as
deeply into affiliate issues and
matters impacting competition.
Given the tiered review of the
approval process, state regulators
ought to use great care when
evaluating proposed transactions.
Otherwise, the outcome of the
federal regulatory review process
could undermine portions of the
analysis carried out by utilities in
support of its state regulatory
requirements.
III. Analytical Review
of the Transaction at
the State Level
Utilities proposing to acquire
new generation resources are
required to develop detailed
analyses in support of their
proposal. The most visible
attribute considered by state
regulators is the levelized cost per
kilowatt of additional generating
capacity. In the majority of cases
before state regulators, this
attribute becomes the focus of the
review process, especially in
those instances where recently
constructed assets are being
considered for transfer to the
regulated entity. In these
34 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
instances the current book value
of an unregulated, affiliate asset is
often compared to either current
costs to build a similar facility or
the costs of other competing
facilities as established through a
competitive solicitation process.10
The most complicated part of
the review process at the state
level usually centers on
projected energy costs. For
newer facilities, this means
projected natural gas costs and
the extent to which realized
energy prices will be sufficient to
allow recovery of fixed costs
including a return on capital.11
Thus, state regulators ought to
carefully examine the bases of the
opinions on future electricity and
fuel prices offered to support the
proposal. In most cases the
underlying analyses are critical to
establishing the extent to which
ratepayers benefit from the
proposed transactions.
Comparable cost estimates
used to support new construction
proposals, or acquisitions, rely on
simulations of plant operations
over a multi-year period using
some form of least-cost dispatch
model. Least-cost dispatch
models are driven by certain key
assumptions – in addition to fuel
prices – specifically those related
to the supply of and the demand
for electric energy and capacity in
a specified geographic market.
While capacity in these instances
is typically viewed exclusively as
a cost, the energy component of
the analysis can be either a cost or
benefit, depending on both the
forecasted supply–demand
conditions in a region, and the
type of generation source being
added to meet future demand.12
Of course it is impossible to
predict the future with certainty.
However, it is critical that the
assumptions underpinning the
analysis supporting the proposed
acquisition receive particular
scrutiny, especially if the decision
is largely irreversible, as is the
case with resource acquisition.
Probably the most important
element of the analysis is when a
proposed transaction requires the
utility to manage the entire
production of the facility going
forward. This puts the buyer in
the position of assuming price
risk, generation or supply
risk, and counter-party risk.
These risks become very
important if the utility forecasts a
period of excess supply during
various parts of the year such that
off-system sales margin (sales
made to wholesale market when
the generation is not needed to
serve native load) is alleged to be
a significant beneficial revenue
stream. To the extent that realized
benefits are subsequently lower,
the overall costs for ratepayers
The Electricity Journal
 will vary from the forecasted
outcome. Moreover, if these
off-system sales are contingent on
the assets being allowed to
transact using market-based rates,
it is crucial that the applicant pass
FERC’s market-based ratemaking
authorization tests. Otherwise the
assets may be required to offer
excess supplies at cost
undermining projected sales
margin benefits.
T herefore, when supply
purchase transactions are
presented to state regulators,
absent fairly straightforward
acquisition of peaking supplies,
the devil will likely be in the
details. Any proposal that
forecasts significant purchases
and sales from the newly acquired
assets will need to be subjected to
careful review to assure it does
not place ratepayers at too much
risk for future shifts in underlying
forecasted variables, and that it
will not run afoul when subjected
to federal regulatory review.
Ensuring that a detailed,
multi-faceted review is carried
out as part of the approval process
can offer assurance that the
appropriate supply options are
selected.
IV. Assessing the
Arguments for the
Transactions and
the Impact of
Federal Regulations
Because these transfers and
potentially premature supply
additions will impact the
wholesale market, it is critical to
November 2004 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
carefully consider the arguments
for the transactions, and the
extent to which they will endure
over long time horizons. Table 2
presents various price and non-
price terms related to the
transactions identified in Table 1
that have in certain instances led
to considerable debate. Although
there are several important issues
related to these transactions,
three of particular importance are
notable: (1) Term: A renewed
need to convincingly forecast
energy prices over a 20- to 30-year
horizon in order to establish
credible arguments of the costs/
benefits associated with self-build
and transfers; (2) The idea that
there are benefits to being
vertically integrated that cannot
be obtained via arms-length
contracts (in many instances
non-price factors related to
operational flexibility, often
called out by competitors as
veiled exercises of vertical
market power); and (3)
The contention that
creditworthiness and
counter-party risk will continue
to be a significant problem
that limits utilities’ ability to
execute long-term contracts.
Considerable debate has
surrounded utilities’ contentions
that these issues can be effectively
‘‘bounded’’ for the purposes of
making asset ownership decisions
that will, over time, lead to
electricity rates lower than those
that would have prevailed
otherwise. In reality we are once
again confronting a situation that
is not yet unfamiliar; regulators
are facing requests to approve
supply acquisitions that will
impact utility rate-bases for
decades. It stands to reason that if
we are to be certain we have
learned from past regulatory
decisions, we need to approach
these transactions with caution
and establish beyond a reasonable
doubt that the supporting
arguments have been validated.
T he first issue we identify—
term—is likely the most
difficult to evaluate. For example,
in nearly all the cases where an
asset is proposed for transfer, or
built, much of the need for the
facility is during times of peak
demand. This means that during
periods of lower demand, the
facility may or may not be able to
make profitable off-system sales.
Given the significant excess
supply conditions in many parts
of the U.S., it is clear that various
assets are, and will be, operating
at lower than expected capacity
factors for several years (in many
instances at higher than expected
costs given the increased
operations and maintenance costs
incurred when operations are
limited). Therefore, the long-run
35
 36
1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003 Table 2: Recent and On-Going Power Procurement Efforts Involving Affiliate Transactions and Self-Build Options
Utility Price/Cost
Union Electric Company RFP respondents claimed to offer
d/b/a Ameren UE lower prices than that of
selected resources.
PSI Energy, Inc. Indicated that if incremental cost
of competition is cheaper,
it will be purchased in lieu
of transferred assets’
output. Although, plants
go into ratebase.
Arizona Public Transfer is said to be
Service (APS) lowest-cost alternative.
Utah Power Stated that Currant Creek is
lowest cost option.
Southern California Indicated that cost is reasonable
Edison (SCE) compared to other plants
recently built in the region.
Georgia Power Selected combination of affiliate
and Savannah and non-affiliate resources
Electric and Power based on cost.
Entergy Services, Inc. on Selected combination of several
behalf of Entergy affiliate and non-affiliate
The Electricity Journal
Transmission Service Credit & Debt
Bland-Franks North-South No
constraint called into question
ability of competitors to deliver
and impacted decision.
N/A N/A
Problem with respect to APS concerned
Phoenix load pocket.
— —
N/A N/A
Network upgrade issues No
were discussed, although
apparently not an impediment.
Indication that network service No
required by RFP was not
Term
10–25 years; although,
10 years used for RFP,
but 25 years for
FERC filing.
N/A
20–30 years
about its
credit rating.
Selected project analyzed
using 35-year term.
Other RFP offers were
for lesser terms.
N/A
7 years and 15 years
Certain affiliate transactions
were for a short term,
Operational, Reliability and
Completion Risk
Additional
value for black start and
non-spinning reserves.
Missouri PSC stated
preference for owned asset.
N/A
Reliability in Phoenix area.
Synergies claimed from
combined dispatch.
Yes; stated considerable
operational flexibility when
compared to other offers.
Also, phased construction.
N/A
Reliability
Various issues associated
with availability, price,

Operating Companies resources based on cost. obtained by an affiliate while others were very and quantity terms and
awarded a contract. long term. Concerns ability to put unit in service
expressed over disparity. over short-time horizon
arose as issues.
 price forecasts used by the utility
to analyze the year-on-year
performance of the asset are
critical to determining the future
costs and benefits. There could be
considerable near-term costs, or
over-estimated future benefits,
neither of which is easy to
forecast.
In addition, particular process
issues related to term and
associated with transfer or
self-build proposals are
potentially troublesome.
Applicant utilities produce
complex, multi-decade
quantitative analyses using
internal modeling approaches
and submit these findings to
regulatory bodies as support for
their requests to transfer or build
new supplies. These submissions
are typically ‘‘verified’’ by an
independent monitor, but there is
usually no independent analysis
carried out by the monitors.
Instead, these experts – often
acting in agency with the
applicants – simply review the
techniques and supply
comparative statistics from
various competitive bids with the
utilities’ own submitted analyses
and propound on how the
differences support the applicants
submission. Not surprisingly,
protest has emerged in all of the
instances where these analyses
have been developed, filed with
state regulatory commissions,
and supported by independent
monitors. The primary complaint
is that competitive suppliers exist
that can meet the utilities’
requirements, but they effectively
cannot compete for reasons that
November 2004 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
vary considerably (see Table 2).
Certainly, it would not seem that
this outcome should apply in all
instances where the issue arises,
but often it occurs. That said, the
debate ought not to be ignored
because the methodology used to
gain approval for the transfer or
self-build option suggests that
this debate is really about utilities’
desire to expand the size of their
ratebase in regions where
restructuring has not taken hold,
but where new generation assets
have been sited.
At the same time, the role of the
regulator is unenviable since
commissioners will find it
difficult to second-guess the
reams of evidence that the utilities
put forth in an affirmative
showing that their chosen
approach is the best option going
forward. Moreover, given the
recent turmoil in the electricity
industry, regulators also have to
listen to claims that chronic
shortages of available generation
capacity could reappear if asset
ownership is not increased given
that the alternative is the
sometimes politically distasteful
choice of forcing utilities to rely
on the competitive market.
U ltimately it may be FERC
regulatory review that
upsets applicants’ ability to push
through long-term proposals
approved by the states. And this
may be in the interest of the states,
even though it may appear to
create jurisdictional tension.
FERC’s role as regulator of
wholesale markets requires it to
closely examine the majority of
these proposals. To the extent
FERC identifies a market power
problem, this should sound an
alarm at the state level that
additional analytical review of the
proposal may be necessary. Any
action FERC takes that invalidates
a modeling assumption must be
examined by the states. In fact,
states could consider examining
different pricing scenarios for
acquired assets to understand
various risks faced by utilities if
FERC questions the transaction.
The long-term nature of the
transaction demands that a
thoughtful, detailed companion
set of future operational scenarios
be evaluated by state regulators.
Second, there are often various
non-price contractual terms
identified such that ownership of
a particular asset is claimed to
offer a level of control or
assurance that cannot be obtained
through bilateral contracts. The
primary concern with this
argument is that in most instances
there are competitive offers
available that – when balanced
against a reasonable assessment
of prevailing risk – provide
essentially the same degree of
37
 flexibility of ownership.
Evaluating the issues that arise
with respect to non-price terms is
often subjective, complicated, and
the source of tension during
federal regulatory reviews where
affiliate self-dealing is sometimes
alleged. For example, eliminating
concerns regarding the nature of
transmission service available to a
facility (and the process through
which it was or must be obtained);
what entity may operate a plant
better over time; and establishing
that a facility will be flexibly
available at all prescribed times,
are difficult at best. All that has
been shown to date is the obvious:
(1) There are benefits of owning
generation that given certain
assumptions cannot be obtained
through bilateral contracts, and
(2) Contracts can be less flexible
than ownership.
O nce again, non-price issues
that are potentially being
used to favor affiliates will likely
only be fully vetted during
FERC’s application of its Edgar
test. The increased awareness
expressed by the FERC, and the
detailed investigations
surrounding the Ameren,
Entergy, and Southern
transactions, indicate little
tolerance for affiliate favoritism.
States again ought to review
transactions carefully and ensure
that there is a fallback position if
FERC finds that proposed
transactions are anticompetitive.
These transactions typically are in
the range of hundreds of millions
of dollars and will not be allowed
to slip under the radar screen at
the federal level.
38 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
Finally, there are issues related
to counter-party risk that exists
absent full ownership that have
emerged when utilities evaluate
long-term contracts as substitutes
to asset acquisition or self-build
options. Utilities and business
analysts consistently cite two
impediments to longer-term
contracts. The first is the concern
that the seller cannot guarantee it
will be able to fulfill the contract
obligations due to current financial
pressures. The second relates to
financial analyst’s requirement
that utilities account for long-term
contracts as imputed debt. There is
reason to believe that these issues
can be overcome to some extent
going forward. With respect to
counter-party risk, it is clear that
generation companies are slowly
working out the debt overhang. As
financial performance is
improved, credit ratings will
improve—especially if solid
counter-parties are committed to
purchasing generation supply.
Second, although off-balance sheet
accounting of longer-term con-
tracts involves reporting them as
imputed debt, there is no reason
that utilities can avoid be
penalized for these contracts if
their use is part of a sound,
long-term procurement plan that
is consistent with regulatory
requirements. In short, short-term,
knee-jerk reactions to these issues
overstate their true longer-term
impact.
A lthough the issues we
identify are a subset of
those that can arise, they have
been the subject of considerable
debate recently. Once again, care
must be taken to carefully
evaluate the impact of these issues
on a proposed transaction.
Decisions that leave wholesale
competitors alienated without
being based on clear, concise
reasoning and analyses that will
stand the test of time will change
the risks faced by market
participants. Moreover, to the
extent that near-term market
conditions potentially drive these
supply acquisitions, the impact
may affect future investment in
generation resources.
V. Conclusion
Wholesale market conditions
are leading to a spate of requests
that generation assets built and/
or owned by unregulated
affiliates be acquired or
contracted out to affiliate utility
companies. These proposals call
in most cases for decisions that
will impact ratepayers for
decades to come. Moreover, there
is evidence that some of the
transactions may be intended to
relieve an unregulated affiliate of
The Electricity Journal
 some currently burdensome debt
in the form of underutilized
generation facilities. To the extent
that the analysis of these
proposed transactions is complex
and subject to various state and
federal regulatory reviews, they
may call for a level of
independent analytical review
that is completely severed from
the applicant utility.
Deciding on an appropriate
approach for ensuring an
independent analytical review
will require that state regulators
carefully review their resource
planning and procurement
processes. Certain recent
transactions that incorporated
so-called independent monitors
have been subject to considerable
scrutiny. The wholesale market
has changed significantly
compared to a decade ago when
many transactions were
associated with the construction
of qualifying facilities. The ability
of market participants to offer
better, more refined products calls
for modified approaches for
Deciding on an appropriate approach will require that state regulators carefully review their resource planning and procurement processes.
November 2004 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
analyzing supply options.
Independent monitors that do
more than look over a utility’s
shoulder are likely required to
provide certainty that all the
details have been considered.
Moreover, as we have described
above, federal regulatory
requirements are an important
consideration in any analysis and
must become an input into supply
planning analyses at the state
level.
G iven that both state and
federal regulatory agencies
are clearly concerned that, going
forward, decisions result in
secure and cost-effective supply
sources, now is the time to
harmonize analyses to consider
all relevant issues. The
considerable number of
second-guessed regulatory
decisions to build generation
capacity in past decades demands
that careful consideration be
afforded to going-forward
decisions. To the extent necessary,
states and FERC ought to
cooperate to limit regulatory
uncertainty and streamline
required analyses. Clearly it
would not be desirable to approve
transactions without at least being
absolutely certain that the risk to
the ratepayer has been thoroughly
analyzed. The last issue that
arguably anyone would want to
emerge again is claims that
entities incur costs now that might
be considered too high, or even
‘‘stranded,’’ sometime in the
future.
Endnotes:
1. This is evidenced in part by
centralized wholesale markets in the
Mid-Atlantic and Northeast that have
reported increased reliance on the spot
market in recent years. See, for
example, PJM 2003 State of the Market
Report, Market Monitoring Unit (Mar.
4, 2004), at 17; and State of Markets
Report, Assessment of Energy Markets for
the Period January 1, 2002 through June
30, 2003, Staff Report by the Office of
Market Oversight and Investigations
Federal Energy Regulatory
Commission, Docket M04-2-000 (Mar.
2004), at 26.
2. APS’ most recent RFP excluded
PWEC from offering a bid based
39
 on its assets given the currently
pending APS request to ratebase
these generation assets. A RFP
conducted in 2002 resulted in
PWEC competing against other
competitive suppliers to win
the right to supply APS
electricity.
3. See FERC Order No. 642, 93 FERC ô
61,164 (Nov. 15, 2000).
4. See Order Conditionally Accepting
Proposed Rate Schedule and Revising
Affiliate Policy, 106 FERC ô 61,183
(Feb. 25, 2004), at 58.
5. See Boston Edison Co. Re: Edgar
Electric Energy Co., 55 FERC ô 61,382
(Jun. 7, 1991), at 62, 168–169. FERC’s
reference to the Edgar test is clearly in
response to the recent Cinergy and
Ameren affiliate transaction
proposals it recently reviewed. In
both of these instances FERC
expressed concern that affiliate
transactions present issues that must
be thoroughly vetted. As more
transactions appeared, FERC
indicated it would apply Edgar going
forward, and that it was going to
review its affiliate transaction
regulatory framework. The Edgar test
identifies three methods by which
affiliate transaction prices can be
compared to extant market data.
These are: (1) A head-to-head
competition to win the right to
supply power to the utility where
the affiliate competes on equal
terms with other market participants.
If the affiliate wins the competition
fairly, Edgar is satisfied; (2) A
comparison of the affiliate
transaction price to other prices
non-affiliated buyers were willing to
pay for similar services from the
affiliate generation facility. If the
pricing is comparable, then Edgar is
satisfied; and (3) Benchmark evidence
can be presented by the applicant
which shows that the prices, terms,
and conditions of sales made by
nonaffiliated sellers compare
favorably to the transaction price.
6. Opinion and Order Affirming
Initial Decision in Part, Denying
Requests for Rehearing and
Announcing New Guidelines for
Evaluating Section 203 Affiliate
40 1040-6190/$–see front matter # 2004 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2004.08.003
Transactions, Opinion No. 473,
108 FERC ô 61,081 (Jul. 28, 2004),
at 68.
7. Purchase power agreements only
require filing at FERC (unless between
affiliated companies), although
eventually the market-based
ratemaking authorization tests
required to obtain authority from
FERC to transact at market prices will
reveal if the agreement results in an
increased ability for the buyer to
exercise market power.
8. Although these reviews are
carried out on a case-by-case basis and
screen failures do not mean that a
proposed transaction will not be
approved.
9. Although there are ways to limit
FERC’s regulatory review of a
particular transaction, it is impossible
to completely evade FERC’s
regulatory oversight unless the asset
in question is never allowed to sell its
production at market-based rates. For
example, it is possible for a utility to
self-build (PacifiCorp’s Utah Power),
but if PacifiCorp is itself ultimately
found to be controlling too much
excess generation capacity, FERC’s
market-based ratemaking
authorization tests will reveal this
situation. Similarly, Southern Power’s
proposed affiliate purchase power
agreements with Georgia utilities were
questioned by FERC such that the
assets are now being proposed to be
transferred to Georgia utilities
(approved by Georgia PSC, June 2004),
but if the assets are ever to make sales
at market-based rates, Southern Power
will have to demonstrate it does not
control too much excess capacity.
10. Requests for proposal for new
supplies typically request that
separate pricing be provided for
capacity and energy. Often capacity is
priced on a dollar per kilowatt-month
basis and energy is priced based on
unit efficiency and fuel prices at the
time the electricity is produced.
11. This does not apply to peaking
facilities that only operate a limited
number of hours per year. For peaking
facilities the primary going-forward
cost consideration is typically the
carrying cost of the facility. Although
there can be opportunities for
enhanced revenue receipts during
times of shortage, regulatory
frameworks render it difficult to
assume that elevated pricing can be
realized with certainty, making the
analysis of carrying costs most
relevant. Of course, recovery of
average total costs is the ultimate goal
of the owner, but actual pricing
approaches will not necessarily be
developed using only costs as a guide.
12. To the extent that the analysis
of various options relies on an
assessment of the capacity cost
and future energy production for
both consumption and sale, a
complete analysis combines both
cost and benefit elements to
determine the least-cost option.
This portion of the analysis can
create a significant amount of
complexity as long-run forecasting
assumptions will significantly
affect the results of the analysis,
and subsequently the overall
estimated costs could be very
sensitive to the input assumptions.
Although there are many important
factors, three stand out. First, fuel
price forecasts and, recently, gas
price forecasts have a substantial
impact on the analysis. Second,
estimates of future demand growth,
and in particular if the growth is
limited to peaks, or applies more
broadly to overall demand,
considerably impacts the results.
And third, the assumed mixture of
future supply additions affects the
overall analysis.
The Electricity Journal