Electric Utility Industry After PUHCA Repeal

1
Electric Utility Industry After PUHCA Repeal

• NARUC STAFF SUBCOMMITTEE ON
• ACCOUNTING AND FINANCE
• APRIL 24, 2006
• CORPUS CHRISTI, TEXAS

ROBERT W. GEE PRESIDENT GEE STRATEGIES GROUP LLC
2
Overview

• Background leading up to PUHCA repeal in the
  Energy Policy Act of 2005
• What the new law (PUHCA 2004) intended and what
  new authority it provides to FERC and the states
• How some states are reacting to repeal to
  protect ratepayers
• How investors regard the role of the states
• Suggestions for how states should proceed under
  the new law

3
Background of Public Utility Holding Company Act
of 1935

• No significant utility state regulation existed
• PUHCA enacted to address financial abuses
  facilitated by complex holding company structures
  and interlocking directorates resulting in
  numerous utility insolvencies and little
  accountability
• Required simplified, limited holding company
  system
• Utility activities limited to a single,
  geographically integrated public utility system
  and to such other businesses as are reasonably
  incidental, or economically necessary or
  appropriate to the operations of the integrated
  system
• Imposed significant recordkeeping and filing
  requirements before the Securities and Exchange
  Commission

4
The Case for PUHCA Repeal

• Over time, PUHCAs restrictions were deemed as
  not reflecting either the market structure or
  regulatory policy priorities affecting the
  modern electric power industry
• Geographic integration requirement
  counterintuitive to blunt growth of market power
• PUHCA Pretzels rendered certain legal
  requirements meaningless
• Over 2 decades, SEC favored its repeal
• Perception grew that repeal was necessary to
  eliminate arcane, duplicative, and unduly
  burdensome regulations that disserved the
  interest of the consuming public by hindering
  needed investment
• Role of FERC and states in ratepayer protection
  had matured
• Would be better equipped to protect ratepayers
• SEC focused on investor protection

5
Basic Premises Reflected in Energy Policy Act
Electricity Title

• Congress concluded that the electric utility
  sector has been in dire need of significant
  capital investment to maintain affordable,
  reliable electric service for the future
• This investment requirement could be met by
  making the sector more competitive from a
  capital-attraction standpoint, extending to a
  more diversified class of investors
• Regulatory reform was required to spawn greater
  capital attractiveness

6
PUHCA of 2005

• Under Energy Policy Act, FERC given expanded
  Section 203 authority to oversee mergers
  acquisitions of electric and gas companies to
  include holding companies, and to prevent
  cross-subsidization by utility of non-utility
  affiliates
• FERC given access to books and records of utility
  holding companies relevant to costs incurred by
  the public utility affiliated with a holding
  company and necessary or appropriate to protect
  utility customers
• FERC authorized to determine certain non-power
  goods and services cost allocations among holding
  company members upon request
• State commissions given a federally enforceable
  right to request access to utility holding
  company books and records, wherever located, with
  certain provisos
• Act does not preempt states from exercising
  jurisdiction under otherwise applicable law to
  protect utility customers

7
FERCs Response to Repeal

• Final rule takes incremental approach to
  exercising new authority
• Streamlined filing requirements in contrast to
  prior SEC requirements
• Chose not to mandate blanket filing of cost
  allocation agreements addressing costs of
  non-power goods and services purchased by
  jurisdictional utilities from affiliated
  companies
• Deferred adopting additional rules regarding
  cross subsidization, encumbrances of utility
  assets, or diversification into non-utility
  businesses
• Preferred to rely on existing ratemaking
  authority under Federal Power Act and Natural Gas
  Act and enhanced merger acquisition authority
  
• Revisit need for expanded action in technical
  conference next year

8
Post-PUHCA State Inquiries

• Some concerned about
• Prospect of increased merger acquisition
  activity
• Greater complexity in detecting utilitys
  cross-subsidization of its affiliates
• Ability to address potential absorption of
  holding company diversification risks by
  regulated utility
• Some have opened dockets to consider adoption of
  ex ante safeguards in anticipation of utility
  holding company diversification and potential
  cross-subsidization
• Examining limits on degree and character of
  holding company diversification (New Jersey Board
  of Public Utilities Staff proposal to limit
  holding company diversification at 25 percent of
  aggregate asset value)
• Requiring structural separation of utility and
  holding company, accompanied by ringfencing
  safeguards (Kansas Corporation Commission staff
  proposal)

9
Considerations to Factor

• In PUHCA 2005 Congress gave states a vote of
  confidence to assume responsibility to protect
  ratepayer interests consistent with federal law
• But will Congress intent to encourage investment
  be negated by state actions tilting too heavily
  in the name of ratepayer protection?
• Investors versus ratepayers presents states
  with a false dichotomy
• Both interests should be balanced in reaching a
  decision, consistent with state and federal laws
  
• Outlook for new Merger Acquisition activity
• Pre-PUHCA repeal accelerated activity (land
  rush) anticipated from more M As and
  acquisitions by new investors
• Post-PUHCA repeal somewhat more sober,
  realistic assessments

10
Investors Perspectives on PUHCA Repeal

• While M As will continue, as before, they still
  will be strategic in seeking value
• Some new investors likely to be interested, but
  will be highly cautious given current regulatory
  risks, lack of familiarity with state or
  U.S.-style utility regulation (in the case of
  foreign investors), and books records
  requirement of PUHCA 2005
• Recent J.M. Cannell, Inc., survey indicated that
  many institutional investors deemed PUHCA repeal
  as benign, but a non-event
• Respondents understood the need for effective
  state and federal regulation
• Generally, they favorably regarded ringfencing to
  protect utility from affiliate or parent holding
  company risks
• But many unfavorably regarded proliferation of
  Wisconsin-type holding company statutes
  (Mini-PUHCAs) in other states

11
Recommended Steps for States Considering New Rules

• If you can, take the time dont rush to
  judgment
• Review existing authority to
• condition and approve mergers
• oversee issuance of debt
• impose restrictions on dividend payouts
• monitor affiliate transactions
• conduct audits
• Examine precedent construing merger approval and
  ratemaking authority to determine if sufficient
  to protect ratepayers
• Questions
• Does the Commission require a broader scope of
  oversight?
• Does the Commission have sufficient resources to
  escalate oversight?
• Can objectives be met through voluntary or safe
  harbor alternatives?

12
Strategic Implications for States Contemplating
Post-PUHCA Rules

• State authority customarily at zenith during
  merger approvals even if express statutory
  authority unclear or ambiguous
• Ambiguity allows commissions to condition outcome
  of requested approval to its favor where case
  resolved through settlement
• But certainty of new rules could undercut
  authority if court finds that adopted rules
  exceed statutory authority
• From a strategic standpoint, is ambiguity or
  uncertainty preferred?

13
Considerations for Seeking New Legislation

• PUC's existing relationship with legislature
  good, bad, or mixed?
• Weigh likelihood of outcomes
• Legislation adopted as requested
• Legislation defeated
• Requested legislation not adopted but alternative
  legislation adopted that PUC dislikes
• Two out of three outcomes are negative

14
Post-PUHCA Closing Thoughts

• PUHCA repeal represents a rare instance of
  Congress modifying federal regulation of energy
  sector and inviting states to share the field
• How states respond to Congress invitation could
  strongly influence pace and degree of future
  mergers and acquisitions and volume of capital
  invested into the sector
• How FERC exercises its new M A authority in
  future cases, in tandem with new PUHCA authority,
  should provide states with guidance, and could
  conceivably lessen need for separate state
  safeguards
• FERC and state commissions are joined at the
  hip in implementing this legislation

15
Robert W. Gee President Gee Strategies Group
LLC 7609 Brittany Parc Court Falls Church, VA
22304 U.S.A. 703.593.0116 703.698.2033
(fax) rwgee_at_geestrategies.com www.geestrategies.co
m