Last of three parts
Two summers from now, you may pay a lot more for electricity.
The companies that wish to buy TXU Corp., Kohlberg Kravis Roberts & Co. and TPG, promised to cut standard electricity prices and keep them low through 2008.
And, they've committed to exhibit restraint in the costs of debt they include in rate cases this year and next for TXU's regulated power-line business unit, Oncor.
But those promises expire in 2009, just when Texas' power supply may become uncomfortably tight, pushing prices up.
A consultant hired by The Dallas Morning News to assess the impact of the $45 billion buyout concludes the deal offers no net benefit for customers. The consultant, GF Energy LLC of Washington, D.C., calls on the Public Utility Commission to negotiate long-term gains for regular consumers.
"The issue is whether the new owners will keep prices as low as possible and, most important, not be inclined to push price increases beyond what other publicly traded utilities will do," the report states. "We do not believe there can be air-tight guarantees that the buyer will not be inclined to squeeze the customers."
The PUC faces a fundamental question: Does a regulator have authority to protect customers in a deregulated market, where, in theory, competition is supposed to promote consumer interests?
The author of the report, Roger W. Gale, says absolutely. Electricity is vital for human health and prosperity. And while he has long promoted competition, he said no market is perfect, and Texas still has behemoths like TXU that can exert great influence.
TXU says any meddling by regulators in the deregulated markets is destructive.
"The Texas Legislature made a public policy decision in 1999 when it mandated a competitive market structure that customer prices would be driven by competition, not regulatory intervention," Mike McCall, head of TXU Wholesale, wrote in an e-mail to Mr. Gale on Wednesday, after receiving the report. "Such intervention would only result in negative consequences to the robust Texas competitive market, driving investment away."
The News gave copies of the report to TXU and the buyers, as well as the PUC, Jim Marston of Environmental Defense and two key legislators, Sen. Troy Fraser, R-Horseshoe Bay, and Rep. Phil King, R-Weatherford. Reporters asked each to comment on the report.
TXU and the buyers declined requests for on-the-record interviews and chose to respond by e-mail.
"TXU has the opportunity in the near term to price low enough to win new customers or, at a minimum, stanch the bleeding of existing customers. Then, in December 2008, when TXU is no longer committed to keeping rates low, they can raise prices again."
The buyout group promised to cut prices 15 percent for about 1 million customers. The promise expires at the end of 2008.
Come 2009, it's anyone's guess what the buyers might do to prices. Raise them to recoup costs? Lower them to draw more customers or to please politicians, as the Texas Legislature goes back into session?
"The buyers believe they will win much more than customers; otherwise the deal makes no sense," the report states.
The promised cut would drop only the standard price that TXU charges, the former so-called price to beat, to 12.75 cents per kilowatt hour from 15 cents. TXU has already implemented a 10 percent reduction. The remainder of the decrease will come once the buyout closes, probably later this year.
The deal doesn't extend to customers on TXU's longer-term pricing plans, some of which are cheaper.
Texas retail electricity rates historically follow the price of natural gas, because most of the state's power comes from natural gas plants. When natural gas prices spiked after Hurricane Katrina, TXU raised its standard retail price 24 percent.
Since that time, natural gas prices have declined, but TXU only recently cut the standard price.
Instead, before the buyout crew came along, TXU had been offering cash bonuses to customers willing to stick with the former monopoly, rather than switch to other providers. And TXU offers lower rates to customers willing to sign long-term contracts. The company has been losing customers each year, with customer count down 6.4 percent in the first quarter compared with the year-earlier quarter.
Competing electricity providers have cut prices here and there as TXU offered its bonuses. Prices in North Texas tend to be in a range of 11 cents to 15 cents per kilowatt hour.
Eventually, pricing could go the way of the deregulated airline industry. Vigorous airline competition has pushed fares down, lower than the price of bus tickets, in some cases. But while an individual airline may cut fares in a given market to win customers, there's a collective desire to charge the highest prices the market will bear.
"Regulation was often put in place to prevent monopolistic pricing, which harms consumers. But deregulation does little to prevent oligopolistic pricing, which can equally disadvantage customers," the report states.
"Reliability might be affected by the new owner's reticence to make capital expenditures. Private equity funds' principal objectives of providing returns to their owners and investors can pose an inherent conflict with utilities' needs for long-term capital investment as well as innovation to ensure long term resource adequacy."
The buyout group curtailed TXU's immediate plans to build more coal-fired power plants and hasn't promised to replace those plants with cleaner technology. Experts say the investors' move, meant to quell public outrage over pollution, could cause wholesale prices to rise.
The buyers' plans could throttle Texas' power supply at a time when population and economic growth are boosting demand for electricity. The Electric Reliability Council of Texas predicts supply will become uncomfortably tight in 2009.
Tight supply means higher, more volatile wholesale prices.
Without more generation capacity, power companies will have to fire up older, more expensive natural gas plants to meet demand. Doing so boosts the wholesale market price, which is set at any given moment by the most expensive plant running, called the plant on the margin.
"The cancellation of eight of the 11 planned coal-fired plants was billed as an environmentally friendly move,"Phil Adams, an analyst with independent bond research firm Gimme Credit, wrote in an e-mail.
"I think it was a useful way to ... ensure that relatively more expensive natural gas fired generation stays on the margin in Texas, thereby making TXU's existing nuclear and coal-lignite fueled capacity (relatively less expensive than gas) that much more valuable," he added.
The buyers have pledged to consider nuclear and coal gasification plants, which use cleaner technology. But they've only promised to hold on to TXU for five years, which isn't enough time to build those types of plants.
"The job of building sufficient generating resources to serve the load in Texas does not properly fall solely on the shoulders of one company or even a small number of companies," Frederick M. Goltz with KKR said in testimony accompanying the buyout filing with the PUC.
"This is best illustrated by the fact that since 1995, there have been in excess of 100 new generating units completed in Texas and not a single one of those units has been constructed by TXU Generation," he said.
In the deregulated power market, competition is supposed to ensure that Texans always have enough power at reasonable prices. Trouble is, regulators no longer have explicit authority to make sure there's enough competition to benefit customers. It's up to power plant investors to decide when and where to build, and what type of technology to use.
Industry experts have praised the Texas retail electricity market for its high level of competition, but many worry that the wholesale market doesn't have enough players with the money to invest in big projects.
"My concern for the medium and long-term is for sufficient generation capacity," said Ehud Ronn, head of the Center for Energy Finance at the University of Texas at Austin. "We don't have sufficient competition at the generation level."
He's concerned that the buyers' environmental stance, and the public resistance to pollution, could make it nearly impossible for any other company to build a traditional coal plant. That could cause retail prices to rise in the short term because of a lack of power, and to rise in the long term because of the more expensive investments that cleaner plants require.
Some state lawmakers wrestled during the recent legislative session with the question of how to boost competition in the wholesale markets. The Legislature passed a bill that would create a committee to study the state's electricity demand for the next 50 years and the infrastructure Texas will need to keep the lights on.
The Legislature would have considered the results of the study during the next session, in 2009.
But Gov. Rick Perry vetoed the bill.
Passing on costs
"One of the criticisms of private equity is the reliance on debt. Increases in interest rates, inflation and unexpectedly low return on investments can result in serious financial problems for holders. For customers, it could mean that the higher cost of money gets passed through to them, and it would almost certainly mean that the owners would try to push up rates."
The buyout group has committed to exhibiting restraint when asking the PUC to set rates for TXU's only regulated business, the power line company Oncor. Yet, a key promise not to pass along higher debt costs expires next year.
The report points out consumers may get stuck paying for TXU's higher costs if borrowing expenses rise.
Other promises from the buyout group soothed some concerns that the report brings up.
The investors won't pass along any buyout-related costs in Oncor rates. They committed to operate the business separately from the competitive units. And they will ring-fence Oncor, which means they'll separate the company's finances from the rest of TXU to protect Oncor from any problems at the other TXU companies.
Such commitments put to rest worries that the buyers might unfairly shift excess costs to the regulated unit from other businesses, to be passed along to consumers in state-approved rates, the report states.
However, there's no guarantee the buyers won't shift costs between the deregulated wholesale and retail units in this way, using, for example, wholesale power plants to secure loans to the retail operations.
The Texas Legislature considered a bill that would have prevented this by requiring each business unit, including the corporate holding company, to operate absolutely separately. The bill failed.
But one key commitment from the buyers has an expiration date. Oncor has promised not to ask the PUC to add any higher borrowing costs to consumer rates for the next two years. But come 2009, Oncor could begin trying to add such costs to the regulated transmission rate, which makes up a small portion of a typical monthly bill.
Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth College, argues that a debt-heavy private equity deal is meant to cut the cost of capital, not raise costs.
"If you put too much debt on to it and the financial risk begins to go up so that the cost of ... debt goes up, then it can turn against you," he said.
"But if you get a somewhat more aggressive capital structure with some more debt, that, for most companies, leads to an increase in their value," allowing the private equity investors to sell the company at a profit down the road, he said.
The trouble is, according to the GF Energy report, consumers might be harmed by rising debt costs, but there's no assurance consumers will share the rewards when the investors cash in. The report concludes that the PUC has a duty to require the buyers share their spoils with consumers.
"If the buyers are winners, customers need to be winners, too," the report states.
Read this series in the Dallas Morning News