6. Divestiture of Generation Assets by Investor-Owned Electric Utilities

Introduction

Previous chapters discussed how investor-owned utility (IOU) mergers and acquisitions are changing the structure of the electric power industry. IOU divestiture of power generation plants is another facet of change in the industry. Divestiture of assets is defined as the sale of assets to another company or the transfer of assets to a nonutility subsidiary.

IOUs are divesting power generation plants at unprecedented levels. Starting in late 1997 through early September 1999, 51 IOUs (32 percent of the 161 IOUs owning generation capacity) have divested or are in the process of divesting 133.0 gigawatts of power generation capacity, representing approximately 17 percent of total U.S. electric utility generation capacity (Table 10). Of the 133.0 gigawatts, 77.0 gigawatts have been sold or are pending completion of the sale, 31.1 gigawatts are up for sale, and 24.9 gigawatts will be transferred by an IOU to its nonutility subsidiary. Some industry observers have estimated that ownership may change for up to 50 percent of total U.S. generation capacity (about 364 gigawatts as of 1998) over the next 10 years. No one can predict with certainty the volume of future divestitures, but more are expected as restructuring of the electric power industry proceeds.

The idea of an electric utility divesting generation assets can be traced back to before November 1996, when the Federal Energy Regulatory Commission (FERC) issued Order 888 requiring electric utilities to allow access to their transmission lines to other electricity suppliers. The FERC believed that access to transmission lines was necessary in order for a competitive power generation market to develop. Some industry participants believed, however, that open access to the transmission system would not be sufficient. When transmission line capacity becomes limited due to high usage, utilities that own the transmission lines will favor power from their own generators over a competitor's generator. Many thought the answer to this potential problem was for the FERC to require utilities that own both power generators and transmission lines to divest either their power generators or their transmission assets.

In Order 888, the FERC took a less intrusive alternative to actual divestiture of generation or transmission assets by requiring " functional unbundling." Functional unbundling is achieved when a company's organizational structure separates operation of and access to the transmission system from power generation.⁽²⁹⁾ To comply with functional unbundling, electric utilities created an open access transmission tariff, established separate rates for wholesale generation, transmission, and ancillary services, and established an electronic information network that supplies information on the availability of transmission capacity to customers. All IOUs have complied with the FERC's functional unbundling requirements and in some regions electric utilities have formed independent system operator (ISO) companies and turned control (but not ownership) of their transmission assets over to the ISOs. This can be construed as a way of unbundling power generation from transmission.

Even though all IOUs have functionally unbundled generation from transmission, and some have formed ISOs,⁽³⁰⁾ divestiture of generation assets continues, brought on by State restructuring initiatives and strategic decisions of electric utilities. Although a utility may have multiple reasons for divesting its power plants, the present high level of divestitures has been prompted by State restructuring initiatives creating retail competition. State officials view the separation of power generation ownership from power transmission and distribution ownership as a prerequisite for retail competition. Some States have passed laws requiring utilities to divest their power plants. California, Connecticut, Maine, New Hampshire, and Rhode Island are examples of States with laws explicitly requiring utilities to divest their fossil and hydroelectric generation assets and, potentially, any ownership in nuclear power generating assets.

In other States that have passed electricity industry restructuring legislation, the requirements for unbundling are not always clear, and they vary from State to State. The State public utility commission (PUC) may encourage divestiture explicitly as a means for recovering stranded costs or reducing market power. Many times the PUCs are not explicit in their unbundling requirements, leaving it to the utility to propose a method that satisfies the PUC's unbundling objectives and satisfies the strategic and economic objectives of the utility. The utility prepares a company restructuring plan which may include selling its assets or, alternatively, transferring its assets to an unregulated subsidiary company. Negotiation and compromise between the PUC and the utility are part of the process of finalizing the plan. Not all States that have restructured their electricity industry require resident electric utilities to unbundle their assets. Table 11 presents a summary of divestiture requirements by State.

Five Census Divisions Accounting for Most Generation Asset Divestitures

Figure 8. Investor-Owned Electric Utility Generation Capacity Divested or to be Divested by Census Division, as of September 1999

Five census divisions--Middle Atlantic, New England, South Atlantic, East North Central, and Pacific Contiguous--account for a total of 121.1 gigawatts of the divested capacity, representing 91 percent of the 133.0 gigawatts of actual and planned divestitures in the United States as of early September 1999 (Figure 8). The majority of divestitures are concentrated in these regions because the States in these regions were among the first in the Nation to promote retail competition. With the exception of States in the South Atlantic Division, most of the States in the other four divisions passed legislation in 1996 or 1997 restructuring the electricity industry, and they have had over 2 years to implement their restructuring programs.

IOUs in New England have just about completed divesting their power plants; approximately 20.3 gigawatts have been sold, representing about 88 percent of the region's generating capacity. Capacity in the region that has not been divested is owned by nonutility related companies or municipal or Federal Government power plants. IOUs in the Middle Atlantic region, mainly New York and Pennsylvania, have divested or are in the process of divesting almost 31 gigawatts, accounting for approximately 39 percent of the region's generating capacity. IOUs in California have divested slightly over 26 gigawatts, representing about 35 percent of the generating capacity in the Pacific Contiguous region.

Dominion Resources (parent company of Virginia Power) tops the list of power generation divestitures (Table 12). Recently, the company announced that all Virginia Power's generation capacity will be transferred to a new nonutility subsidiary, Dominion Generation. Unicom (formerly Commonwealth Edison), serving the Midwest region, has sold or plans to sell almost 50 percent of its generating capacity, consisting of a mix of coal- and gas-fired generating plants. Unicom will not exit the generation business entirely, keeping its large nuclear power fleet of over 12 gigawatts of capacity intact. Unicom stated that it will use some of the proceeds from the sales to reduce the operating costs of its nuclear plants to make them more competitive with other power plants.

Two California utilities, Pacific Gas & Electric and Southern California Edison, were required to divest 50 percent of their fossil-fueled power plants. Combined, they have divested about 70 percent of their generation capacity. Individually, they rank as third and fourth highest, respectively, in total capacity divested in the United States. Interestingly, Pacific Gas & Electric Corporation sold its generating capacity in California, but through its affiliated independent power producer, Pacific Gas & Electric Generating Company (a wholly-owned subsidiary of Pacific Gas & Electric Corporation), it is one of the leading purchasers of generating assets in other regions. Pacific Gas & Electric Generating Co. purchased most, if not all, of the generating capacity sold by New England Electric System in early 1998. This is an example of a trend in the power generation business where an electric utility holding company expands its power generation capability in regions outside of its regulated utility's franchise area. Many electric utility holding companies are growing in this way.

Types of Generation Assets Divested

Figure 9. Power Generation Divestitures of Investor-Owned Electric Utilities by Fuel Type, as of September 1999

Coal- and gas-fired plants top the list of divested power plants (Figure 9). About 46 gigawatts of coal-fired capacity (15 percent of total coal-fired capacity) and 41 gigawatts of gas-fired capacity (28 percent of total gas-fired capacity) have been divested or are up for sale. There are three reasons fossil fuel plants top the list. First, coal- and gas-fired power plants combined account for approximately 64 percent of U.S. electricity generation capacity, and it is reasonable that divestiture of those plants would follow a similar distribution. Second, because of their relatively low production costs, coal-fired plants are a desirable investment, assuming they are well maintained. Production costs of coal-fired plants average 1.8 cents per kilowatthour, making them among the lowest cost plants operating today. In addition, coal prices are expected to continue falling, which should bring production costs down even further. On the downside, however, coal-fired plants can be controversial because of SO₂, CO₂, and NO_x emissions.

The majority of gas-fired plants divested were old steam turbine plants that have perhaps a less promising future than coal-fired plants. Even though their production costs have declined over the past few years, existing gas-fired steam turbine plants remain more expensive than coal plants and other new power plant technologies. However, because existing gas plants have established access to gas supplies, it is reasonable to assume that, over time, many of them will be replaced by more efficient gas combined-cycle plants, thus making the sites on which the plants are located valuable in themselves. The use of natural gas combined-cycle plants is expected to increase over the coming years.

Third, many States that have opened the industry to competition have encouraged the divestiture of fossil-fuel plants first, while delaying recommendations for divestiture of other plants (especially nuclear power, which in 1998 was the second largest power source for generation in the United States). For example, California initially requested Pacific Gas and Electric and Southern California Edison to divest at least 50 percent of their fossil-fueled plants; but both companies will maintain ownership, at least over the intermediate future, of their nuclear power capacity. The New York Public Service Commission insisted that utilities divest fossil and hydroelectric plants to help ensure fair competition but delayed any decision covering nuclear power until further study was completed.

Delaying divestiture of nuclear power plants is justified, in part, because of the more difficult and complex issues associated with nuclear generators compared with other power plants. First of all, because nuclear power has stringent safety requirements, the capability of new owners to operate nuclear power plants must be evaluated to determine that they will continue to meet the safety requirements. The Nuclear Regulatory Commission has this responsibility. Further, nuclear power plant owners must maintain a decommissioning fund to cover the expenses of safely shutting down the plants when they are retired, which has been shown to be quite expensive. New owners must demonstrate their ability to maintain the funds. The time and resources it takes to buy a nuclear power plant may also distract from the desire of potential purchasers. Estimates range from 12 to 18 months to obtain regulatory approval to transfer ownership of a nuclear power plant.

Nevertheless, a few nuclear power plants have been divested. Currently, 9.1 gigawatts of nuclear power generating capacity have been sold, and another 4.2 gigawatts are up for sale. Because nuclear power plants are, in many cases, jointly owned, some of these sales involve only a portion of the plant. For example, Niagara Mohawk Power Company, in its effort to divest all generating assets, announced early this year its intention to sell Nine Mile Point unit 1, which it owns outright, and a 41-percent share of Nine Mile Point unit 2. Also, Virginia Power, which owns 3.2 gigawatts of nuclear power capacity, will transfer ownership of its plants to Dominion Generation, a nonutility subsidiary of Dominion Resources.

Three nuclear power plants, which are not jointly owned, will change ownership entirely. In July 1998, General Public Utilities announced the sale of Three Mile Island unit 1 to AmerGen Energy, Inc.--a joint venture of the Philadelphia-based utility company, PECO Energy, and British Energy PLC. When this sale is completed, which is expected in 1999, it will be the first time a nuclear power plant in the United States has changed hands. Closely following this transaction, Boston Edison announced in November 1998 the sale of its Pilgrim nuclear power plant in Massachusetts to Entergy Nuclear Generating Company. This sale was the first completed competitive bid for a nuclear plant in the United States.

Recently, Illinois Power announced that it was selling its Clinton nuclear power plant to AmerGen Energy. The sale of the Clinton plant supports the notion that single-unit nuclear operators (i.e., operators that own only one nuclear plant, such as Illinois Power) will eventually sell their nuclear assets to larger companies specializing in owning and operating nuclear power plants. AmerGen Energy and Entergy Nuclear are two companies that have expressed an interest in expanding their nuclear power business. One way to expand is by purchasing nuclear plants; another way is by merging with a company that owns nuclear power capacity.

Wide Variation in Selling Prices of Generation Assets

The selling price (or purchase price) of generating capacity is determined by a variety of factors, including the plant's age and condition, fuel, and location, among others.⁽³¹⁾ The projected electricity demand in regions surrounding the plant and other market factors also come into play. Thus, it is not surprising to see a wide variation in the selling price of power plants (Figure 10). Power plants that are being transferred from an IOU to a nonutility subsidiary at book value are not included in this analysis.

Figure 10. Percent of Capacity Sold by Price Range and Fuel Type, as of September 1999

About 80 percent of the gas-fired capacity that has been divested has been sold for less than $300 per kilowatt of capacity. In contrast, coal-fired plants were significantly more expensive on average. Only about 10 percent of the coal-fired capacity divested has been sold at $300 per kilowatt or less. From the standpoint of operating costs, the price differentials are reasonable. The relatively low price for gas compared to coal is consistent with the fact that the steam turbine gas plants have on average a higher production cost than coal plants; this probably lowers the value and selling price of gas plants. Hydroelectric plants have sold at a relatively high price on average; approximately 50 percent of the capacity divested has been sold for $750 per kilowatt or more. This is not surprising because hydroelectric plants have relatively low operating costs and can effectively compete in a competitive energy market with plants using other fuels. Also, they can be brought online rapidly, which is valuable when the demand for electricity is higher than normal.

Although there is a large variation in selling prices by type of fuel, IOUs have received relatively high prices for their power plants across all fuels, except nuclear power. Most of the generating capacity has sold for more than book value, ranging from 1.5 to over 2.5 times book value (Figure 11). Book value is the original cost of the plant minus accumulated depreciation.⁽³²⁾ These relatively high prices indicate a strong market for existing generating capacity, and some of the buyers believe that they can recoup their investments in a competitive market. In some instances, buyers may be bidding up the prices of existing plants because they are interested in expanding generation capacity at the site, and they can bypass the difficult and time-consuming job of locating and obtaining approval of new sites. For example, Sithe Energies, a foreign-owned independent power producer, recently purchased Boston Edison's non-nuclear plants. Sithe indicated that it plans to build gas-fired generators on two of the purchased sites.

Figure 11. Estimated Average Selling Price of Power Generation Capacity by Fuel Type, as of September 1999

The selling prices of power plants might be higher than expected in part because of the selling method. Most of the plants were sold through competitive auctions which, if properly designed, can produce higher prices and greater revenues for the seller than would strictly negotiated sales.

Nuclear facilities are the only plants that have not sold at high prices. The Pilgrim and Three Mile Island nuclear plants recently sold for significantly less than their book values. The uncertainty of the future of nuclear power, and the additional safety and regulatory requirements compared with other fuels, contribute to the relatively low selling prices. Also, weak demand, manifested by relatively few buyers interested in acquiring nuclear assets, may contribute to low selling prices.

Buyers of Power Generation Assets

Virtually all the generation capacity that has been divested to date has been acquired by companies classified as independent power producers (IPPs). IPPs are independent from regulated electric utilities; they do not own bulk power transmission or distribution lines, and essentially they are unregulated companies that produce and sell power in wholesale markets or directly to wholesale customers under bilateral agreements. Of the 101.9 gigawatts of divested capacity for which a new owner has been announced, 100.2 gigawatts will be acquired by IPPs. The preponderance of independent companies is expected because the central idea of divestiture is to unbundle an electric utility's ownership of power generation from its ownership of transmission and distribution.

Figure 12. Buyers of Divested Power Generation Capacity by Type of Buyer, as of September 1999

The interesting point is that most of the divested capacity is being acquired by nonutility subsidiaries of utility holding companies (Figure 12), referred to as utility-affiliated IPPs. Of the 101.9 gigawatts of divested capacity, 83.4 gigawatts (82 percent) has been acquired by IPP utility affiliates. These acquisitions allow electric utility holding companies to expand their power generation business outside of the traditional service areas of their regulated utility subsidiaries. For example, Southern Energy, an IPP owned by the Southern Company, recently acquired a total of 6.6 gigawatts of generation capacity in California, New England, and Indiana. Southern Company owns five electric utility subsidiaries in the Southeast region of the United States, and it is one of the largest electric utility holding companies and producers of electricity in the United States.

Although IPPs have been producing power on a small scale for some time, recent acquisitions of generation capacity demonstrate that IPPs are becoming major players in the U.S. power generation business. The top 10 companies, all of which are IPPs, have acquired almost 68 gigawatts of divested generation capacity, representing about 67 percent of the divested capacity for which new owners have been announced (Table 13). Dominion Generation, the newly created IPP affiliate of Dominion Resources, leads the list and will own and operate all of Virginia Power's generation capacity when the transfer is completed. Closely following is Edison Mission Energy, a subsidiary of Edison International Corporation (which also owns Southern California Edison), with an acquisition of 11.3 gigawatts. Edison Mission Energy purchased generation assets from Unicom and is now a major power generation company in  the Midwest.  The data suggest that IPPs as a whole are not only growing in terms of owning more generation capacity, but with these recent acquisitions, ownership of capacity within the IPP sector is becoming more concentrated.

Selling Generation Assets and the Approval Process

How power plants are sold is important to the owner and potential buyers. The procedure should ensure fairness to all interested buyers and ensure that the utility gets a fair market value. The most popular divestiture method is the auction. The advantages of auctions are that they have been used successfully for many years to sell products, they can be easily understood and monitored, and they can produce greater revenues than other methods, if designed properly.

Many of the IOUs divesting assets have used a two-stage auction process. In the first stage, the utility advertises the sale of the plant and bidders submit notifications of interest back to the utility. Advertising the sale of the plant can be accomplished in many ways. One way is to develop a potential buyers list and send each one a notification that a power plant is for sale. In the second stage, the utility selects a "shortlist" of buyers. Short-listed bidders conduct due diligence and submit their final bids. Sometimes post-bid negotiations are conducted, but they have the tendency to reduce the bid price because the bidder, knowing that negotiations will be conducted, can change the original bid price.

When the divestiture involves many plants, packaging of the plants is important. Packaging refers to the group of assets that will be sold at one auction. In many cases, bidders cannot submit a bid for just some of the assets, but must bid on all the assets in the package. Thus, it is important to combine assets in a way that will interest potential buyers.

Appendix B contains case studies describing how three utilities went about selling their power plants and some key issues they faced. The cases were selected to represent different States and conditions under which utilities are divesting their power plants.

All power plant sales must be approved by the PUC of the affected States. The PUC examines the sale's impact on the utility's customers, the environment, and other public interests, and resolves any conflicts which arise. Ideally, contentious issues are resolved during the planning stage.

With the exception of hydroelectric power plants, the Federal Government has only a small role in IOU asset divestitures. The FERC's position is that generation assets are not under its jurisdiction and its approval is not required unless the sale includes transmission assets along with generation assets. That position is being challenged, however, by the American Public Power Association (APPA). The APPA claims that Section 203 of the Federal Power Act gives jurisdiction to the FERC, and has filed a petition requesting the FERC to assert its review authority over the sale of generation assets. The APPA's petition is still open.

Endnotes

32. Book values suffer similar problems as selling prices. They are based on values reported in the press or gleaned from 10-K reports for the seller, and they are only rarely available on a plant-by-plant basis. For sales involving plants fired by several fuel types (i.e. primary natural gas, and secondary oil), the book value was proportioned according to capacity for each fuel type. This may tend to overstate the value of older plants. Also, book values may be distorted by the differing real estate and inventory values associated with each sale. A further problem is the time dependency of book values. The data used here try to use a book value as close to the closing date of the sale as is possible.

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