Electric Power Industry Overview New Challenges New Opportunities

1
Electric Power Industry OverviewNew Challenges
New Opportunities

• David K. Owens
• Executive Vice President
• Edison Electric Institute
• May 26, 2005

2
Status of U.S. Electric Policy

• Changing supply / delivery picture
• Overbuilt generation / inadequate transmission in
  some regions
• Concern over supply, price and quality for
  natural gas
• Greater scrutiny over market behavior
• Mandatory and enforceable reliability standards
  contemplated
• More reliance on renewable resources, demand
  response and efficiency
• Markets look different blend of competition and
  regulation
• 19 states plus DC with retail competition
• FERC getting strong political push-back in
  approach to wholesale markets
• Twenty Senators raised concerns about FERC
  actions in individual cases
• Reliability and market power FERCs chief
  concerns
• Resource procurement evolving issue

3
Status of U.S. Electric Policy

• Strong regional disagreements re wholesale
  competition
• SE, West
• Strongly oppose FERCs SMD and Federal intrusion
  into planning, siting and resource adequacy
• NE, Mid-Atlantic, Mid-West
• Favor wholesale competition and Regional
  Transmission Organizations (RTOs)
• State PUCs seeking deference to their views
• Native load priority
• Resource planning, acquisition and adequacy
• Pricing of transmission expansion
• Allocation of costs of existing transmission
• Rates for bundled retail transactions
• Reliability

4
Status of U.S. Electric Policy

• Congress seeking to adopt comprehensive energy
  legislation
• Controversy looms
• Multi-emissions legislation stalled
• Wall Streets continuing concerns about investor
  confidence
• Bankruptcies and collapse of merchant power and
  energy trading sectors
• Wholesale market development stuck in
  transition
• Federal / state conflicts on resource procurement
• Wall Street is demanding greater certainty to
  support infrastructure investment

5
Challenges In Resource Options
6
What Powers Our Plants?
7
Fuel mix by region map
8
Generation Options Affected By Public Policy
New Generation Capacity By Fuel Since 1950
Source Henwood Energy Consulting
9
Challenges with Each Option

• Coal Certainty on environmental rules /
  policies, transportation, land use
• Nuclear Relicensing, waste storage,
  decommissioning
• Gas Infrastructure enhancement, supply, price,
  quality
• Hydroelectric Relicensing streamlining, fish
  mitigation
• Renewables / new technologies Funding,
  integration into grid
• Purchase power imputed as debt on balance
  sheets
• DSM Cost recovery, price responsive demand

Goal Diverse resource portfolio
10
Map of Coal dependency
11
Trends in electric power generation chart
Trends in Electric Power Generation 1980 - 2025
Coal
Gas
Nuclear
Renewables
Oil
Source US Department of Energy, Energy
Information Administration
12
Future Investment Issues

• Federal and state regulations
• Cost recovery
• Traditional
• Competitive markets
• Financing
• Environmental
• New Technology
• Combustion
• Gasification
• Clean coal and carbon dioxide

13
Coal Future

• High natural gas prices and clean coal technology
  funding are spurring prospects for new coal-based
  power plants
• New plants have exceptionally low emission rates
  due to state-of-art pollution controls
• However, impediments remain to further use of the
  USs 250 year domestic supply of this low-cost
  energy source

14
Projections of Baseload Coal

• 87 GW of coal capacity additions through 2025
• 100 billion in investments
• 20 GW of new coal-fired generation has already
  been announced
• 14 billion in coal plant pollution control
  equipment

Sources EIA Annual Energy Outlook 2005 Morgan
Stanley Capex Study
15
Urgent Need For Regulatory Certainty

• Regulatory uncertainty will prevent prudent
  investments in baseload generation capacity
• Need
• Sensible multi-emission legislation to harmonize
  overlapping requirements to reduce SOx, NOx and
  mercury emissions
• Public policies that foster greater deployment of
  advanced clean coal and IGCC technologies
• Effective federal state cooperation on resource
  procurement issues

16
The Delivery System
Industry structure affects expansion and planning
17
Transmission Congestion Has Increased
Dramatically
2004
Requests for transmission loading relief (TLRs)
in the Eastern Interconnection
2002
2000
Level 2 or higher TLRs
1998
Source NERC Transmission Loading Relief
Procedure Logs
18
Siting (NIMBY) Remains Huge Challenge

• Building new facilities is one of most
  significant hurdles for reliability
• Requires years of painstaking consultation
• Siting approval is elusive
• 50 state, 50 rules (local, county, Indian and
  Federal lands, etc.)
• Network does not respect geographic boundaries
• Siting may be required for thru states that see
  no benefits
• Access across Federal lands very complicated
• Potential role for Regional State Committees
• Need comprehensive energy legislation

19
FERC Says Utilities Not Building

• FERC continues to question the industrys
  commitment to invest in transmission
• FERC believes IOUs are not building enough
  transmission
• FERC concerned that lack of transmission
  investment is an exercise of vertical market
  power market based rates at risk
• FERC believes that vertically integrated
  utilities not sufficiently focused on
  transmission part of business

20
Actual and Planned Transmission Investment by
Shareholder-Owned Electric Utilities (1999-2008)
Planned
Actual
Data represents Shareholder-owned electric
utilities. Consumer Price Index (CPI) used to
adjust for inflation from year to year. Planned
total industry expenditures estimated from 90
response rate to EEIs Electric Transmission
Capital Budget Forecast Survey as of 3/11/05.
Actual expenditures from EEIs Annual Property
Plant Capital Investment Survey and FERC Form 1s.
21
Transmission Capital Budget Survey

• Industry plans to increase transmission
  investment to levels not seen since the mid-1960s
• 1999 to 2003 - 17 billion in transmission
  investment by shareholder-owned utilities
• 2004-2008 - 28 billion planned investment 60
  increase over prior period
• 1999-2008 - 10 annual increase for combined
  actual and planned investment

22
How Should We Finance Needed Infrastructure?
23
Troubling Statistics and Trends

• Credit crunch for much of utility sector
• Wholesale market power frustrations
• Generation boom-bust cyclicality
• Increases in transmission congestion and
  line-loading relief (TLR)
• Dramatic fuel and power price volatility
• Large power procurement disallowances for
  distribution companies
• Opportunistic retail customer switching unrelated
  to suppliers marginal costs

24
The New Challenges

• Provider of last resort
• Competitive wholesale and retail markets
• Investments with uncertain customer loads
• Reduced ability to absorb cost increases or
  revenue decreases
• Tension between federal and state rules and
  regulations
• Legislative uncertainty
• Cost escalation in price capped environment
• Investment community perception

25
New Risks

• Volatile wholesale energy costs
• Among the most volatile prices anywhere in the
  economy
• Major uncertainties re. optimal timing of
  purchases
• Potential for hindsight prudence
• Non-performance by third party suppliers
• New entities in the supply chain
• Exposure increases with duration of purchase
  commitment
• Federal / state conflicts
• RTO costs
• Congestion costs
• Market power standards, requirements

26
New Risks (Cont)

• Provider of last resort
• Retail choice / customer switching increases load
  volatility, adds to risk of wholesale price
  volatility (above)
• Aggressive arbitrage by large customers shifts
  risk to incumbent utility
• Cherry picking of utility customers
• Volumetric rate designs
• Interclass return differentials increase large
  customers incentive to leave
• Result - loss of the utilitys most profitable
  customers hurts the bottom line

27
Investment Challenges

• Many needed investments are contingent in nature
  
• Investments in security or blackout prevention
  create large potential for prudence reviews
• No event spent too much
• Terrible event spent too little
• Regulatory instability and ambiguity encourages
  delay of investment
• Rules still unresolved
• Cost recovery, prudence, performance
  responsibility, incentives, further potential
  unbundling (or rebundling)
• Ratings anxiety and precariousness
• After Enron, credit rating agencies now appear
  highly sensitive, even over-reactive to even
  modest changes in the health of energy companies.
  

28
Investment Challenges

• Heightened volatility and associated exposure to
  imprudence findings
• Extreme volatility and boom-bust cyclicality
• High probability future will not be as predicted
  ? decisions imprudent
• Insufficient allowed returns for the degree of
  risk the industry faces
• Many risks and problems are new
• Not the kinds of risk that will be observable in
  the financial statistics

29
Regulatory Challenges
30
The Return of Rate Cases

• Restructuring rate caps coming off transitions
  periods over
• Increasing capital investment needs
• Generation, Transmission, Distribution
• Annual capital expenditures 3 Billion higher
  than 2004 over next 5 years
• Increasing cost of doing business
• Fuel costs
• Wholesale market costs
• Wholesale market structure RTOs, ISOs
• Decreasing interest rates
• Environmental mandates
• Environmental compliance
• DSM, energy efficiency
• Renewable Portfolio Standards

31
Outlook 15 Year Lull Over!

• 40 cases in next several years (up from 15 last
  year)
• Regulatory environment
• Low interest rates
• Increasing costs
• Pension funds
• Fuel
• Power
• Lost expertise
• Regulatory lag

32
Jurisdictional Quagmire Transmission, Resource
Procurement, RTOs and Reliability
Creating tremendous uncertainty!
33
Electricity Whos In Charge?

• FERC and States both claim authority over
  interstate transmission for retail services
• FERC has no power to site facilities necessary
  for wholesale markets to thrive
• FERC to defer to regional state committees
  Issues? How much?
• RSC are not decisional entities, states have
  explicit authority over planning and resource
  adequacy decisions
• FERC increasingly examining resource procurement
  issues in individual cases

34
FERC and Market Power

• FERCs Vision
• Create a competitive wholesale energy market that
  will promote economic efficiency and ensure
  generation adequacy
• Mitigate horizontal and vertical market power
• FERCs Approach
• Behavioral and structural market power mitigation
  measures
• Market-based rate authorization
• Resource acquisitions
• Acquisition of merchant plants, affiliate plants
  or purchases from affiliates
• FERC Screens for Horizontal Market Power
• Concerns raised on market share screen
• Failure means cost-based mitigation rates
• Individual mitigation plans (Sec. 206 proceeding)

35
EEIs View On Market Power Contestable Load
Analysis

• An historical analysis of the wholesale loads
  that were actually seeking competitive supply
  alternatives (contestable loads) along with an
  analysis of the competitive resources that were
  available to serve those loads
• Includes a demonstration that the contestable
  loads had access to the competitive resources
  transmission access was available
• The relationship between the contestable loads
  and competitive resources provides a more
  accurate picture as to the competitiveness of the
  market.

36
What is Market Power ?

• The ability to profitably sustain prices above
  competitive levels by using
• Horizontal market power (withholding generation)
• Vertical market power (limiting transmission
  access)
• Barriers to entry (limiting competitor access to
  resources or markets)
• Affiliate abuse (preferential treatment of
  affiliates)

Protect competition not competitors
37
FERCs Objective

• Create a competitive wholesale energy market that
  will promote economic efficiency and ensure
  reliability
• Key steps to implement vision from FERCs
  perspective
• Mitigate Horizontal Market Power
• Reduce concentration of generation ownership
• Increase opportunities for merchant generators
• Mitigate Vertical Market Power
• Functional separation of generation and
  transmission
• Address affiliate abuse
• Remove barriers to entry

38
The Key Questions

• How to assure the development of wholesale
  electric markets without second-guessing or
  duplicating state resource adequacy and
  procurement policies and decisions?
• How to harmonize state and Federal input into
  resource procurement to remove uncertainty for
  infrastructure investment?

39
Federal and State Harmony on Resource Procurement

• The benefits of robust wholesale competition can
  be achieved only if a strong effective state
  federal working relationship is established on
  all regulatory matters that provide the stability
  and certainty needed to attract investment (EEI
  Board, January 7, 2005)
• Key issues
• Harmonizing public policies
• FERCs evolving policies on generation market
  power and competitive resource procurement with
• State policies concerning electric resource
  adequacy and procurement
• Addressing emerging topics
• Political debate about economic and efficient
  dispatch

40
Federal and State Harmony on Resource Procurement

• RESOLVED, that a forum should be developed with
  input from (stakeholders) regarding proper role
  for State commission, regional bodies and FERC
  in utility resource and acquisition decisions to
• Identify perceived gaps between Federal and State
  regulations, policies or practices
• Identify best practices for resource planning,
  procurement and acquisitions
• NARUC Board of Directors, February 16, 2005
• Dialogue conducted May 16, 2005 encouraging the
  formation of working groups to address evolving
  issues

41
Energy Bill
42
Energy Bill Infrastructure Issues

• Electric reliability organization
• FERC enforced mandatory standards
• Transmission
• Accelerated tax depreciation
• Granting FERC limited backstop siting authority
• Streamlining the Federal permitting process
• Requiring FERC investment incentives
• Supply
• Promote natural gas supply and clean coal
  technologies
• Streamline hydro relicensing and preserve nuclear
  option
• Extend renewable tax credits
• Corporate flexibility / market development /
  consumer protection
• Repeal PUHCA, Reform PURPA, prohibits deceptive
  roundtrip trading, expands FERC enforcement
  authority, extends authority to FTC to protect
  consumer privacy

43
Energy Bill

• Electricity issues unresolved in Senate
• Repeal of PUHCA
• FERC merger authority
• Resource Portfolio Standards
• Participant funding
• Environmental issues?

44
Achieving Robust, Competitive Energy Markets for
Customers

• Things we have learned so far?
• We need the infrastructure to make it happen
• We need an effective state-federal working
  relationship to provide stability and certainty
  to attract infrastructure investment
• We need strong supply and delivery providers to
  make it happen

45
What We Have Learned About Providing Prosperous
Markets?

• Markets dont follow the promises
• Real markets can be volatile and more expensive
• Supply and demand really are related!
• Can we keep them in balance?
• Electric markets are closely tied to financial
  markets
• How do we finance badly needed investments?
• Good market design is critical!
• Can we harmonize FERC / States /Congressional
  Agendas?

46
Summary

• Restore investor confidence
• Ensure access to capital on reasonable terms for
  infrastructure enhancements
• Clarify rules for competitive market development
• Must provide the flexibility and incentives
  needed to ensure a strong and reliable system
  that benefits consumers and recognizes regional
  differences
• Adopt a comprehensive energy policy
• Provide the right incentives to grow the
  electricity system and provide a clear direction
  for the future
• Adopt a comprehensive approach for
  multi-emissions
• Provide a clear direction for the future
  Regulatory Certainty