New York, June 10, 2002 — Fitch Ratings has released comments regarding the credit impact of FERC’s recent ‘show cause’ order.
On May 8, 2002, the US Federal Energy Regulatory Commission (FERC) launched a ‘Fact-Finding Investigation of Potential Manipulation of Electric and Natural Gas Prices’.
This involved a public request for confirmation or denial that market participants had employed certain trading strategies. This request was sent to more than 150 market participants involved in the western US power markets.
The types of transaction involved cover a variety of different trading strategies practiced by Enron.
The variety of strategies appear to contain elements of ‘legitimate aggressive competition’, a concept recognized by the California Independent System Operator (ISO) (which may include some forms of price arbitrage between marketplaces), and more dubious practices (e.g. scheduling power flows in opposite directions to net out, yielding a congestion fee, without ever having scheduled generation in the first
This ambiguity is further complicated by the broad terms of the FERC investigation. FERC’s objective in this is not to uncover illegal acts, but rather to determine whether or not legal behavior ‘failed to adhere to the proper standards’ in maintaining ‘just and reasonable rates’. Thus the FERC’s ultimate decisions will inevitably incorporate a wide range of highly subjective criteria.
The initial deadline for responses passed on May 22, 2002. On June 4, 2002, four companies were selected for further investigation. Spokesmen for FERC have stressed that this does not preclude the possibility of similar action by the agency against any other respondents at a later date.
The four who face further investigation are Avista Corporation (Avista), El Paso Electric Company (EPE), Portland General Electric Company (PGE), and Williams Energy Marketing & Trading Company (WMT). At stake is the potential revocation of the companies’ market-based rate authority (MBRA). FERC has at times used its power to revoke MBRA as a way to signal the seriousness of its intentions and to incent companies to fuller compliance with FERC policies or orders.
If a revocation of MBRA is ultimately ordered, the effect is two-fold. First, the companies involved are obliged to revert to a system in which power sales are priced no higher than cost-of-service rates based upon actual costs including a reasonable return, rather than at market-determined competitive prices.
Three of the four entities ordered to show cause are load-serving utilities, and they have less at stake in continuing MBRA for future transaction than does WMT, an active wholesale marketer. Second, FERC has broad power to order refunds of prices received by the company in excess of the cost-of-service rate for a retroactive period back to the date at which the company violated a FERC guideline or charged unjust or unreasonable rates.
The potential impact of such a decision in credit terms would be determined less by the order of revocation and consequent amendments to prospective rates, than by any related refund liability which may or may not ultimately be ordered. As yet no refund liability proposal has been made. Each of the four companies has until June 14, 2002 to respond and ‘show cause’ why the company’s market-based rate-making authorities should not be revoked. Fitch regards the strategy of FERC in issuing the show cause orders as indicative of FERC’s seriousness in pursuing the investigation and obtaining full cooperation from the respondents.
In the case of Avista (senior secured ‘BBB-‘/senior unsecured ‘BB+’/ Rating Outlook Stable by Fitch), Fitch’s current ratings reflect the significant pressure the utility experienced due to unrecovered energy procurement costs. The ratings also assume that Washington regulators will approve the company’s recently announced settlement agreement in its pending rate case. If the settlement agreement is approved, Fitch anticipates a sharp rebound in operating cash flows in 2002 and 2003, from depressed levels in 2001.
The FERC action currently targets the regulated utility division, Avista Utilities, which did not have substantial amounts of transactions at market-based rates, rather than the trading subsidiary Avista Energy. According to the company, the transactions in question with FERC occurred in April-June 2000, and represent less than one-tenth of one percent of the utility’s trading activity during the period.
Fitch considers the possibility and severity of refunds in the case of Avista to be relatively small.
In the case of EPE (first mortgage debt ‘BBB-‘/ senior unsecured ‘BB+’/Rating Outlook Stable), the FERC has questioned the company’s involvement with the trading strategies of Enron through an alleged joint operational relationship between EPE and Enron Power Marketing Inc. FERC noted that Enron personnel manned EPE’s trading desk ‘75% of the time during 2000-2001’.
EPE’s response to the FERC questionnaire seemed to the FERC to indicate an unwillingness or inability of EPE to provide information about actions by Enron as EPE’s agent. Fitch is unable to determine from publicly available information the potential exposure of EPE if retroactive refunds were ordered.
As for PGE (first mortgage debt ‘BBB’/senior unsecured ‘BBB-‘/short-term ‘F3’/Rating Watch Negative), Fitch explicitly cited concerns regarding ongoing investigations into the western power markets in its press release of May 22, 2002. In addition to the negative overhang from the investigations, PGE also faces continuing uncertainty regarding its ability to refinance near-term maturities in the wake of ongoing exposure related to the bankruptcy of its parent, Enron. FERC in its show cause order questions PGE’s responsiveness with regard to trading activity on 17 days in April-June 2000. According to management, the transactions in question represent an insignificant fraction of the company’s trading volumes during the period. However, the ongoing risk of a significant refund cannot be ruled out.
In the case of WMT, Fitch recently commented on the potential positive effects of an enhanced deleveraging program at The Williams Companies, Inc. (WMB; senior unsecured ‘BBB’/short-term ‘F2’/Rating Outlook Negative). Fitch believes that the potential removal of market based rate-making authority could materially impact the profitability of WMB’s energy marketing and trading business, which contributed roughly 30% of adjusted consolidated EBIT excluding non-cash mark-to-market earnings.
Moreover, the margins that WMB could earn in future contracts for the unhedged portion of its power tolling portfolio could be impaired. Fitch will continue to monitor any impact that either MBRA revocation or any subsequent refund liability may have on WMB. In the meantime the Rating Outlook for WMB remains Negative.
Fitch continues to examine event risk concerns arising from the numerous regulatory and other investigations now occurring into the western US power markets in its surveillance of rated entities. As further information permits Fitch to estimate the risks of such litigation, Fitch will take appropriate rating action.