Storm Warning:

Merger madness in utility industry threatens reliability


Shortly after making landfall along the Gulf Coast of Florida last October, Wilma was downgraded to a Category 2 hurricane with top winds around 100 mph. Nevertheless, power outages were unprecedented. Over 3 million Florida Power and Light customers lost power, including 98 percent of Miami-Dade and Broward counties. Ten thousand utility poles that were supposed to withstand winds of 119 mph crumpled, 240 substations were knocked out, and Florida regulators launched an investigation to find out why.

But you don’t have to be Sherlock Holmes to figure this one out. Since 1991, Florida Power and Light has cut operating and maintenance costs per customer by over 35 percent. Between 1995 and 2002 the Florida Power & Light workforce was slashed from 14,500 to 9,800. Between 2002 and 2004 the utility decreased per-customer tree trimming costs by 5 percent, accompanied by a sharp increase in tree-related outages.

State regulators say that it would take the utility 60 years, at its current pace, to inspect all of its poles.

You might think that Florida Power & Light, chastened by Wilma and under investigation, would embark on a crash program to rehabilitate its infrastructure. The utility has the cash — its stock price has performed almost 20 percent better than the average electric company over the past five years. But Florida Power & Light has found a better use for its money. Recently, the utility announced that its holding company, FPL Group, will purchase Constellation Energy Group — familiar to Californians as one of the out-of-state energy pirates forced to settle with the state’s attorney general for gaming California’s electricity market in 2000-2001.

The FPL-Constellation marriage was made possible by the repeal last August of the Public Utility Holding Company Act. But their merger is little more than the advance winds of a monster storm of utility consolidation now gathering on the horizon. For the utility customer who expects reliable service, for the utility employee who depends on a stable employer, for the retiree who relies on a regular dividend from a “safe” utility stock, there may be no safe harbor when the storm arrives.

A World Without PUHCA

For generations, Americans have received electric service from utility companies close to home. The mission of these companies has been to provide everyone with safe, reliable service at the cheapest possible price. State regulators, answerable to the public’s elected representatives, have provided the oversight needed to make sure that utility companies do their job.

But imagine a different approach to electric service:

Your utility is no longer located in your home state, it’s headquartered in Texas — or Tokyo. Your utility’s finances are no longer made secure by a guaranteed rate of return on investment, but are controlled instead by global oil companies or venture capitalists. When your rates go up or your service takes a dive, your state legislator calls up the head of the utility — but no one’s answering the phone in Texas or Tokyo.

Welcome to a world without PUHCA.

It’s a world we’ve seen before, according to Lynn Hargis, a lawyer who spent 10 years at the Federal Energy Regulatory Commission and another 17 years helping companies comply with PUHCA.

“The last time there was no PUHCA we had a Great Depression,” Hargis wrote in her 2003 monograph PUHCA for Dummies. “PUHCA was enacted because huge holding companies were using secure utility revenues to finance and guarantee other, riskier business ventures around the world.” In the seven years following the great stock market crash of 1929, 53 utility holding companies went bankrupt and 23 others defaulted on interest payments.

Holding companies didn’t collapse because electricity was no longer profitable. They collapsed, Hargis says, because they had looted their utility subsidiaries to finance non-utility investments And their collapse deepened and prolonged the Great Depression.

The Public Utility Holding Company Act of 1935 was championed by President Franklin D. Roosevelt to prevent a resurrection of these enormous utility conglomerates and the havoc they wrought on the U.S. economy. Hargis explains how this historic law worked:

  • PUHCA made it possible for states to regulate utility holding companies by limiting the types of business they could engage in, and also by limiting their geographic size.
  • PUHCA, by controlling holding company dividends, loans and guarantees based on the utility subsidiary, made it harder for holding companies to loot their utility subsidiaries .
  • PUHCA regulated self-dealing among the holding companies’ various affiliates.
  • PUHCA imposed controls over utility acquisitions of other utilities or other businesses.

And PUHCA worked. For seven decades, electric service was assured by utilities whose profits were closely regulated, whose shareholders were protected, and whose obligation to serve was written into law. No speculators need apply.

Not everyone liked PUHCA. Gas and electric service generate a lot of money, and PUHCA severely limited the ability of private investors to get their hands on it. Federal energy bills in 1978 and 1992 modified PUHCA, creating opportunities for nonutility investments in the electric industry. The stage was set for Enron to champion “competitive markets” in the 1990s and for investors like billionaire Warren Buffet to push for outright repeal of PUHCA in recent years.

Utility holding companies haven’t waited for PUHCA’s repeal to start testing their ability to siphon money out of their regulated subsidiaries.

State regulators in Kansas found that Westar Energy of Topeka had quietly shifted more than $1.95 billion of debt onto the utility side of the business through intercompany loans and other means, according to a Wall Street Journal report in December 2002. John Wine, then chairman of the Kansas Corporation Commission, told the Journal that utility holding companies “can go pretty far down the road of commingling utility assets before it gets detected,” and expressed concern about the impact on service and rates.

In 2001, Duke Energy transferred as much as $124 million in expenses from its unregulated divisions to the books of Duke’s utilities. E-mail messages showed a protracted campaign by Duke accountants to shift expenses onto the utilities, according to the audit. Regulators might never have noticed if they hadn’t received an inside tip.

Michael Valocchi, a utility consultant at IBM Consulting Services, told the Journal in 2002 that his utility clients were under orders to cut capital spending by as much as 30 percent in 2003, in some cases to free up funds for use by the holding company parents.

But this disturbing trend received little media attention and the campaign to repeal PUHCA continued, achieving success on Aug. 8, 2005 when President Bush signed the Energy Policy Act.

A Faster Crowd

After PUHCA officially exits the stage in February 2006, what will become of America’s utility companies?

One thing we know for sure: there will be a lot fewer of them. Utility mergers and acquisitions were already gaining traction before President Bush signed the energy bill last August.

In late 2004, Chicago-based Exelon merged with Public Service Enterprise Group — the parent of New Jersey’s largest utility — in a $13 billion deal. In May of 2005, Duke Energy bought Cinergy, combining the parent companies of utilities ranging from the Carolinas to Kentucky, Indiana and Ohio. Also in May, Buffett announced he would buy PacifiCorp, with utility operations in Oregon, Washington, Wyoming, California, Utah and Idaho.

FPL Group’s planned purchase of Constellation Energy sheds light on the character of such mergers.

FPL Group, a holding company, gets most of its revenue from its regulated subsidiary, Florida Power and Light. But in recent years FPL Group had begun to dabble in unregulated power generation and wholesale telecommunications services, and was clearly yearning to run with a faster crowd.

Constellation Energy is that faster crowd. A major player in the wholesale power market, Constellation gets less than a quarter of its revenue from its regulated subsidiary, Baltimore Gas and Electric. FPL Group’s acquisition of Constellation will make the combined company the nation’s largest marketer of wholesale electric power.

Gold Rush

Utility corporations won’t be the only ones to notice the new profit opportunities in the utility industry following the repeal of PUHCA. Oil companies, for example, are flush in the wake of last fall’s hurricanes. Exxon Mobil currently has $34 billion in spare cash.

“Is an Exxon or Shell a potential buyer? I say yes,” says Jim Hunter, utility director for the International Brotherhood of Electrical Workers in Washington, D.C. It’s understandable, he says, that a company in possession of oil and gas resources would be interested in acquiring companies that use those resources. “I think utilities are going to be a target.”

With the utilities’ enormous customer base up for grabs, acquiring utilities could turn into a corporate gold rush. And big oil won’t be the only industry saddling up its pony for the ride.

“There is something about electric and natural gas utilities, with their captive, rate-paying consumers, that is irresistible to venture capitalists,” says Hargis, the former FERC lawyer. “They want to use those guaranteed revenues to invest in risky, potentially high-profit, nonutility schemes. They want to keep the profits and have the utility’s customers bear the risks and assume the debt.”

Utility stocks, for decades a safe repository for retirees’ savings, could morph into short-term investment properties. Tyson Slocum, who works on energy policy at Public Citizen in Washington, D.C., says private equity funds could seize the opportunity to “Grab a utility, squeeze money out of it and toss it aside for the next buyer.”

The gold rush will be global. As Stuart Caplan noted last October in Infrastructure Journal: “Overseas investors interested in acquiring critical mass in the U.S. utility sector will no longer be stymied by PUHCA’s … requirements.”

What Is A Utility For?

In announcing the merger of their holding companies in late 2004, Exelon and PSEG executives sounded almost giddy over the possibilities for their new, combined company.

They talked about how they would “create efficiencies.” They enthused about “operational synergies” and “improved asset optimization” and “cash-flow growth.” They gushed over the opportunity to improve “financial flexibility” and positioning the company “to meet the changing landscape of the energy industry into the future.”

But all of this post-PUHCA sloganeering and “positioning” begs a central question: What is a utility for?

Most people believe a utility’s purpose is to keep their homes lit and heated, to power their businesses, to do whatever planning and maintenance is needed to keep service reliable, and to respond effectively and immediately whenever that service is interrupted.

Do “operational synergies” and “financial flexibility” serve to further that purpose?

The Exelon-PSEG executives predicted in December 2004 that “synergies” would start out at $400 million and grow to $500 million annually by the second year. Synergy, if you believe Webster’s, means “to work together” such that the total effect is greater than the sum of the parts.

The Exelon-PSEG executives, however, seem to think that synergy is just another word for saving money. About 85 percent of the savings, according to their projections, will be “cost related.” These savings include “the elimination of duplicative activities” and “improving operating efficiencies” and “improved sourcing.”

Still not clear? The executives go on to explain that “a portion of any job losses will be offset by anticipated retirements and normal attrition.” Or to be still clearer: “Reductions due to the merger are estimated at approximately 5 percent of the consolidated workforce,” which boils down to a loss of 1,400 jobs.

Utility workforces, apparently, are no longer being downsized, they are being “synergized.” But changing the word for slashing the workforce will not alter the reality that utilities nationwide are already short of the people they need to maintain service reliability at the level Americans have historically enjoyed.

Reliability at Risk

The utility workforce overall was reduced by 25-30 percent during the 1990s, when utilities believed that downsizing was the way to prepare for retail electric competition. Now that shrunken workforce is quickly aging. By 2010, half of today’s experienced utility workers are likely to retire, according to numerous published reports.

Some top executives may regard this mass attrition as an opportunity to save money for the next merger or takeover. But some people question how utilities can continue to function if there is continued attrition of the workforce.

“It is possible to end up with a scenario where some utilities are operating like utilities in third-world countries,” says Steven Kussmann, executive director of the Utility Business Education Coalition in Reston, Va., quoted in a story in the November-December 2005 newsletter of the American Public Power Association. “They won’t have a sufficient number of qualified people to operate them. The result will be dangerous working conditions and unreliable power.”

Five Florida Power & Light linemen interviewed by the Miami Herald in November said the utility had thinned their ranks so drastically that the crews now spend most of their time doing “revenue jobs,” like hooking up new customers rather than performing maintenance on existing infrastructure, which may explain why Hurricane Wilma encountered so many rotten power poles.

Inadequate tree trimming around power lines has been implicated in costly wildfires, and worse. When an untrimmed tree branch in Ohio contacted a sagging transmission line in August of 2003, the resulting explosion knocked out power to 50 million people in eight U.S. states and two Canadian provinces, costing $6 billion. A blue ribbon panel convened by Illinois Gov. Rod Blagojevich found that inadequate tree trimming, obsolete equipment and inadequate training contributed to the severity of the outage.

At a time when utilities ought to be plowing resources into trimming trees away from power lines, replacing aging gas lines and rotten power poles, and hiring and training the people needed to do this work, they are having trouble staying focused on their essential mission. They’re looking for “synergies” when they ought to be looking for linemen.

If it’s hard to keep utilities focused on reliability issues as PUHCA fades into history, it will be even harder if utilities fall under the ownership of oilmen or financiers, according to Tom Schneider, an independent energy consultant and former director at the Electric Power Research Institute (EPRI).

“Traditionally you get to be a (utility) CEO by learning the business,” says Schneider. But if these homegrown CEOs are replaced by new management brought in from outside the industry, there will be a “total loss of any technical understanding or judgment” at the top of the company.

“They’re just not going to understand the industry. That translates to (not understanding) workforce requirements,” Schneider says. As utilities are absorbed into ever-larger holding companies, there will be a “dilution of management attention” to service issues.

Who’s In Charge?

The Energy Policy Act had the virtue of converting voluntary reliability standards into mandatory standards, and giving enforcement powers to the Federal Energy Regulatory Commission. Given its past commitment to “the market,” though, it’s hard to be optimistic that FERC will perform this role effectively.

As Hargis, the former FERC attorney, noted in 2003, the agency has shown no stomach for interfering with holding companies that want to use their utility subsidiaries as cash cows: “FERC has, under its deregulation experiment, uniformly granted blanket approvals under the Federal Power Act for all stock issuances and loan guarantees based on utility assets for all electricity sellers that sell at market-based rates.”

Residents of California remember how reluctant FERC was to intervene in the energy crisis of 2000-2001. “California trusted that the Federal Energy Regulatory Commission would step in and regulate if necessary, which was a huge mistake — the FERC has never shown any ability to regulate on a state-by-state basis, much less the political will to do so,” former California Public Utilities Commission (CPUC) President Loretta Lynch said in an interview last year with UC Berkeley News.

The state hemorrhaged $40-70 billion before FERC finally stepped in and imposed price caps on wholesale power.

Even if FERC had the will and resources to act as enforcer, mandatory reliability standards may not be a powerful enough tool to get the job done. FERC could levy fines on individual utilities for having too many outages, but will the prospect of such fines be enough to persuade utilities to make the investments needed to keep the system reliable?

Schneider, the former EPRI director, is skeptical. What’s left out of the reliability standard, he says, is the long-term adequacy of the workforce.

“Having a commitment that five or 10 years from now your staffing is going to be well-trained and of sufficient size is not included” in any standard, he says.

Last Line of Defense

State regulatory commissions may be the last line of defense for customer service. In California, any takeover of a regulated utility would have to be approved by the state Public Utilities Commission, which also has legal standing to address service quality issues. To what extent that authority will translate into actual power is one of the big unknowns in the post-PUHCA world. Consumer advocates often complain that state regulatory commissions, in terms of staffing and resources, are outmatched by the utilities they regulate.

But today’s utilities are shrimps compared to the supersized holding companies expected to emerge from the coming consolidation of the industry. How will state commissioners stack up against a huge holding company with operations in dozens of states and countries? Schneider believes regulators will have less influence over the highest levels of executive management.

The staff of the CPUC knows where to find executives of Pacific Gas & Electric, headquartered just a few blocks away in downtown San Francisco. “But what if the headquarters is in Texas, or worse, Tokyo?” asks Schneider. “Where are the big financial institutions — Tokyo, London, Hong Kong.”

Some state regulators are growing concerned. The California Public Utilities Commission — one of four state commissions examining the impact of PUHCA repeal—started rulemaking in November to reexamine the relationship of the state’s major utilities with their holding company parents and their affiliates.

“With the repeal of PUHCA the commission’s responsibility to protect the ratepayers becomes even more paramount,” the CPUC said.

One model that state commissions could consider is the Wisconsin Public Utility Holding Company Act, or WUHCA. Enacted in 1985, WUHCA limits the amount a Wisconsin holding company may invest in non-utility ventures, protecting utility customers from risky investments that go bad. WUHCA also requires that the state’s Public Service Commission approve any sale of more than 10 percent of the holding company.

“WUHCA trumps PUHCA,” says Dave Poklinkoski, business manager of IBEW Local 2304, which represents employees at Madison Gas & Electric and has actively battled against utility deregulation. He’s confident that Wisconsin’s law will prevent Exxon Mobil or some investor group from taking over that state’s utilities.

Unions like IBEW Local 1245 can play a role in keeping the focus on service reliability in the states where its members work. The union can explain to employers, to regulators, to legislators and to the public what it takes to keep the lights on today, and the investments in manpower that are needed to make sure the lights are on 10 years from now.

But the storm gathering on the horizon is of a size and character it has not faced before. The Enron fiasco was bad enough, but Enron was limited by PUHCA to owning just a single regulated utility. Now PUHCA is gone. Just as Enron’s bright young hot-shots felt compelled to exploit every conceivable chink in the regulatory armor, an army of corporate takeover artists is now circling the utility industry with one thought in mind.

You can be pretty sure it’s not “service reliability.”

(Editor’s Note: Eric Wolfe is communications director of IBEW Local 1245 in California. This article was posted for re-publication by the International Labor Communications Association.)