Pipes & Wires

THE MONTHLY CLIENT NEWSLETTER FROM UTILITY CONSULTANTS

Issue 52 – June 2006

From the director…

Welcome to Pipes & Wires #52 – this issues starts with an examination of four “almost deals” that could’ve or might still re-shape the energy sector in their respective countries. We then have a look at the threat of re-regulation in the US state of Maryland, take a quick look at the expansion of the Dampier – Bunbury Pipeline in Western Australia, and end this issue with an update on the nuclear power debate in the UK. So until month …. happy reading.

About Utility Consultants

Utility Consultants Ltd is a management consultancy specialising in the following aspects of energy networks…

· Mergers & acquisitions	· Asset management
· Strategic studies	· Financial analysis
· Economic regulation	· Risk management

To be sent a detailed profile of recent projects, pick this link.

EU – E.On moves one step closer to Endesa

Introduction

Readers will recall from Pipes & Wires #49 that E.On made a “surprising but not really surprising” bid for Spanish utility Endesa. This article and the immediately following article examine some high-level happenings and regulatory manoevering that promises to influence Europe’s rapidly unfolding energy sector.

Background

E.On has a clearly articulated “On Top” strategy that has been examined in Pipes & Wires #23 and #48 and which identifies five regional growth ambitions based on existing business platforms. As part of this strategy E.On made a bid in late 2005 for ScottishPower plc that ultimately came to nothing and then in February 2006 E.On unveiled its unsolicited €29.1b cash offer for 100% of Endesa in the face of Gas Natural’s €21b offer for 100% of Endesa. It was widely expected that a successful acquisition of Endesa would augment the On Top strategy with a sixth regional ambition covering the Iberian and Latin American energy markets.

Recent events

E.On’s unsolicited bid received a leg-up a few months back as the EU’s internal market commissioner threatened Spain with legal action for favoring Gas Natural’s bid. The rest of this rather complex tale unfolds in the next article.

Spain – and Gas Natural doesn’t

Introduction

Pipes & Wires #50 described the regulatory issues that Gas Natural encountered as part of its unsolicited bid for Endesa (and Pipes & Wires #51 examined similar issues in the context of Suez and Gaz de France’s proposed merger). This article examines the latest EU competition policy events and how that could tilt the shape of the EU’s emerging energy markets in favor of E.On.

Background

One of the key issues to emerge from regional consolidation is the pressing need to strengthen security of national energy supplies – Germany did it by encouraging E.On to acquire Ruhr Gas, Spain has done it by encouraging Gas Natural to acquire Endesa, and the French are trying to do it by encouraging Gaz de France to merge with Suez in preference to ENEL.. The difficultly with this national security of supply approach is that it tends to push the boundaries of the EU competition rules.

The competition policy issues

Late last year the EU competition regulator concluded that the proposed Gas Natural acquisition of Endesa didn’t have sufficient trans-national impact to fall under EU jurisdiction. As a result, the matter was referred back to the Spanish competition tribunal for approval which seemed alright. It then emerged that Gas Natural may have agreed with Spain’s second largest utility Iberdrola to on-sell between €7b and €9b worth of assets to Iberdrola to avoid anti-trust breaches.

Recent events

Two significant events have occurred over recent months that may well shape the emerging EU energy market.

· A court ruling in Madrid which indicated that Gas Natural’s suspected agreement with Iberdrola may have breached EU rules promoting competition across a single European market.

· The EU’s internal market commissioner was considering taking action against the Spanish government for giving its energy regulators power to block a foreign bid.

The seeming implications of these events are that enhancing national energy security through the creation of strong national utilities would seem to have to take second place to pan-European competition, and making regulatory concessions in advance (“horse trading”) seemingly unacceptable.

As the future of Endesa becomes clearer, Pipes & Wires will make further comment.

Aus – the plug is pulled on Snowy

Introduction

A series of previous articles (Pipes & Wires #49 and #50) on the planned float of Snowy Hydro have mentioned that individual ownership stakes were likely to be restricted to fairly low levels. This article intended to discuss why Snowy is so valuable, and what those ownership restrictions would be but was gazzumped by the very recent decision of all three governments to withdraw their stakes from the sale process.

The real value of Snowy

Both the Snowy Mountains assets and the gas-fired Valley Power and Laverton plants provide valuable insurance to the electricity market because of their quick-start MW capability. Hence a key driver of Snowy’s value is the amount of snow that falls in the Snowy Mountains, and the volatility of temperatures in Sydney and Melbourne. Little thought is required to see how ownership of Snowy by a single utility could influence this market to the detriment of other participants, which has led to the development of a number of restrictions on ownership.

The ownership restrictions

Last month the three governments announced the ownership restrictions on Snowy. In addition to the expected cap on individual stakes, Snowy will be required to…

· Remain incorporated in Australia.

· Maintain its head office in Cooma.

· Maintain a substantial business in Australia.

· Ensure that no less than two-thirds of its directors are Australian citizens.

The cap on individual stakes will be 10% along with a total foreign cap of 35% which will remain in place for 4 years from the day Snowy lists on the ASX, and can only be removed thereafter with the consent of 75% of shareholders.

The sale process withdrawal

Earlier this month the Federal government withdrew its 13% stake in recognition of growing public disquiet over the sale of an Aussie icon. This was quickly followed by the NSW and Victorian governments withdrawing their 58% and 29% stakes from the sale process. So that pretty much brings what was shaping up to be an exciting story to a rather sad ending.

UK – Brit Energy looks to sell coal-fired plant

Introduction

Although dismissed by official sources as “speculative”, news emerged late last month that previously-troubled nuclear generator British Energy might be going to sell its 1,960MW coal-fired Eggborough plant in Yorkshire for as little as £900m (about half its nominal value). This article briefly examines Eggborough’s value to British Energy, reviews BE’s trouble past and examines the basis for the sale.

The value of Eggborough to British Energy

Eggborough’s value to British Energy lies primarily in its slew rate relative to nuclear plants – the rate at which it can ramp generation up or down in response to changing demand, which is something that nuclear plants cannot easily do. Hence Eggborough provides valuable load-following ability to British Energy so the big question must therefore be “if its so valuable why is it being sold”. Possible reasons for its value to other organisations are the flue gas desulfurisation plant and high wholesale power prices, but hopefully the following analysis will provide some further insights.

British Energy’s troubled past

Pipes & Wires #20 described the issues that prompted British Energy’s journey to the edge of bankruptcy (issues that seem to have since faded away) whilst Pipes & Wires #32 and #37 went on to describe the subsequent restructuring that saw the UK government holding about 65% of the shares and existing bond holders assuming a 33% shareholding through a debt-for-equity swap leaving existing shareholders with only a 2.5% stake. An additional group with a strong influence in ownership is the group of secured creditors known as the “Eggborough banks” which funded the original purchase of Eggborough from National Power in 2000.

The proposed sale

Part of the Eggborough banks interest includes an option to buy Eggborough in March 2010, and it is this option that the banks seem keen to sell while both power prices and earnings from coal-fired plants are high. It is also understood, however, that British Energy may have a pre-emptive right to buy Eggborough, and given the value of Eggborough’s slew-rate it may well do so. An alternative could be for British Energy to contract with any new owner for load-following services.

Possible bidders

Possible bidders for Eggborough are though to already include Centrica and RWE. Pipes & Wires will make further comment if this sale proceeds.

US – can deregulation be undone ??

Introduction

The community at large tend to remember electric deregulation in most states of the US as a total disaster, especially California (which was a hot topic in Pipes & Wires #1, #2, #14, #33 and #36). Aside from the issues that California adopted a flawed regulatory model and that deregulation in other states such as Pennsylvania and Texas has proved successful, calls for a return to regulated electric supply seem to be a popular election ticket.

This article examines the return to regulated electric supply advocated by Maryland Governor candidate Douglas M. Duncan and then asks whether simply repealing the deregulation law makes sense.

Recent events in Maryland

Duncan’s stance seems to have been prompted by Baltimore Gas & Electric’s proposed 1 July tariff increase of 72% which has been approved by the Maryland PSC. Part of Duncan’s election ticket also seems to be the apparent unwillingness of current Republican Governor Robert Ehrlich and the other Democrat candidate Baltimore mayor Martin O’Malley to tackle the issue (although having had a quick read of O’Malley’s personal website it’s hard to see how Duncan reaches that conclusion). On the face of it there wouldn’t seem to be too much wrong with that argument – it probably has a lot of popular appeal.

Now here’s where this gets interesting. Duncan wants electricity to again be regulated by the state, as it was prior to 1999 - he says it would automatically mean lower customer bills. "Well it would go back to the way things were, where you'd basically be charged what it cost to make electricity," Duncan said.

Some analysis of deregulation

I guess Duncan’s underlying assumption is that price rises since deregulation are solely the result of private profit being added to otherwise stable costs. However most of us will appreciate that deregulation allows markets to set costs and the big crunch comes when prices actually increase. Critics of deregulation are quick to cry “market failure” however even a little thought would reveal that creating a wholesale market in the face of generation shortages (as happened in California and Ontario to name just two) will lead to price increases, a clear demonstration that the market has worked. Probably the other issue would be the flawed model adopted in California in which retail tariffs were fixed and utilities such as PG&E and SoCalEd had to divest their generation. No surprises that without these natural hedges they bled cash every time the air-con load climbed.

Is re-regulation that simple ??

I guess in the world of politics everything is simple – afterall a stroke of the Governor’s pen could re-regulate Maryland’s (or any other state’s) electric supply. But would it automatically lower customers’ bills as Duncan claims ?? Unless the generators have built new capacity and secured low price fuel (or simply forced to adopt some fabricated tariff) it would seem unlikely.

Probably the really unseen victim if re-regulation was to occur is private property rights – presumably most market participants bought chunks of the market with real cash in anticipation of making a fair return over an extended period of time. Curtailing their returns without compensation is likely to dampen their enthusiasm for investing anywhere in the energy value chain or indeed the infrastructure sector.

Aus – expanding the Dampier-Bunbury pipeline

Introduction

Many of us are aware that one of the original privatisation objectives of the Dampier – Bunbury Pipeline was to enable expansion of its capacity to meet growing demand for both reticulated gas and electricity generation. This article examines the DBP’s recent confirmation of expansion plans that continues on from Pipes & Wires #40.

Background

The pipeline was originally constructed with a nominal capacity of about 520TJ/day. Readers will probably also remember that a key aspect of the privatisation process was to enable expansion of the pipeline. To this end, bidders were recommended to base their bids on a tariff of $1/GJ to Perth and $1.08/GJ to Bunbury but were also warned that subsequent regulatory determinations may decree lower tariffs. In the final event, the decreed tariffs were about 25% lower than those recommended to bidders and the pipeline went into receivership. Pipes & Wires # 33 has the details.

The proposed expansion

Overall demand increases from the various pipeline users is expected to be about 375TJ/day with final commitments being required any time now. Due to the difficulties of accurately forecasting demand increases, the DBP has announced a staged expansion of which the first stage (known as 5A) will provide an additional 190TJ/day of capacity somewhere in the first half of 2008 at a capital cost of about $430m. It is expected that two subsequent expansions known as 5B and 5C each comprising a further 100TJ/day of capacity will be confirmed later in 2006 and during 2007 respectively.

UK – continuing the nuclear debate

Introduction

Pipes & Wires #40 reported Tony Blair’s announcement that the UK might need to build 10 new nuclear power stations to replace its aging stock of MAGNOX and PWR reactors. This article examines Blair’s subsequent announcement that the UK might need to build 20 new nuclear plants.

Recent issues

Pipes & Wires #37 outlined a number of energy issues that the UK faces such as the decline of North Sea gas for which nuclear would seem the best replacement. Pipes & Wires #47 discussed recent research that increasing demand for electricity and the staged closure of aging plants would require more than 10 new nuclear stations. Throw into the mix the recent gas supply interruptions in the Ukraine and the need for the UK to ease its dependence on imported energy becomes even more important.

The recent announcements

In a speech to the Confederation of British Industry last month Blair announced his support for the nuclear option, which is “back on the agenda with a vengeance” citing issues of climate change and energy security. In a similar vein, Blair’s chief science advisor Sir David King indicated that nuclear should supply about 30% of the UK’s electricity (up from the current 19%) as part of the UK’s contribution to tackling climate change.

Pipes & Wires will closely follow this debate as it unfolds. One thing is for sure – it is unlikely to go away.

Conferences & events

8^th Annual New Zealand Energy Summit – Wellington (17 – 18 July)

Conferenz is pleased to announce the 8th Annual New Zealand Energy Summit. Scheduled at speaker and delegate request to ensure the best timed industry gathering, we promise a significant conference experience. The summit covers the vital issues in energy…

· Current issues in power & generation.

· Achieving medium & long-term energy security solutions for New Zealand.

Plus – a separately bookable workshop (full day on the 19 July)…

· Confronting climate change and emissions reduction in the energy sector.

Complex Infrastructure Project Performance – Wellington (22 – 24 August)

Over two action-packed days, New Zealand’s leading infrastructure project management experts will provide you with valuable insights into different aspects of infrastructure projects, highlighted by case studies of some of the most ambitious projects ever undertaken in New Zealand. Key presentations will examine early project planning, infrastructure funding, risk management, project delivery approaches, alliancing, BOOTS, managing projects in heavily regulated environments, developing and instilling project culture, community and environmental issues, the RMA, and delivering complex projects.

Also separately bookable 3^rd day workshop on “Identifying, evaluating & mitigating your project risks”.

Any old books in your library ??

I’m looking for old books and magazine articles on electricity industry and borough council history, especially books like jubilee celebrations of utilities or back copies of the old “Live Lines”. If you’ve got any old books like this that you don’t wish to keep please send them to me.

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If you get this is a hard-copy, your comments can be emailed to issue#52@utilityconsultants.co.nz If you receive this second-hand by email, you can receive Pipes & Wires directly by picking here.

Hot links to cool stuff

· Free 6 Week trial of Dr Penny Burns weekly “Strategic Asset Management”.

· This link connects to the (time-delayed) Australian energy market

Disclaimer

These articles are of a general nature and are not intended as specific legal, consulting or investment advice. They are correct at the time of writing. Utility Consultants Ltd accepts no liability for action or inaction based on the contents of Pipes & Wires including any loss, damage or exposure to offensive material from linking to any websites contained herein.