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[Senate Hearing 108-11]
[From the U.S. Government Publishing Office]

                                                         S. Hrg. 108-11

             FINANCIAL CONDITION OF THE ELECTRICITY MARKET

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                                   TO

RECEIVE TESTIMONY REGARDING THE FINANCIAL CONDITION OF THE ELECTRICITY 
                                 MARKET

                               __________

                             MARCH 4, 2003

                       Printed for the use of the
               Committee on Energy and Natural Resources

                                 ______

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                            WASHINGTON : 2003
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               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                 PETE V. DOMENICI, New Mexico, Chairman
DON NICKLES, Oklahoma                JEFF BINGAMAN, New Mexico
LARRY E. CRAIG, Idaho                DANIEL K. AKAKA, Hawaii
BEN NIGHTHORSE CAMPBELL, Colorado    BYRON L. DORGAN, North Dakota
CRAIG THOMAS, Wyoming                BOB GRAHAM, Florida
LAMAR ALEXANDER, Tennessee           RON WYDEN, Oregon
LISA MURKOWSKI, Alaska               TIM JOHNSON, South Dakota
JAMES M. TALENT, Missouri            MARY L. LANDRIEU, Louisiana
CONRAD BURNS, Montana                EVAN BAYH, Indiana
GORDON SMITH, Oregon                 DIANNE FEINSTEIN, California
JIM BUNNING, Kentucky                CHARLES E. SCHUMER, New York
JON KYL, Arizona                     MARIA CANTWELL, Washington
                       Alex Flint, Staff Director
                     James P. Beirne, Chief Counsel
               Robert M. Simon, Democratic Staff Director
                Sam E. Fowler, Democratic Chief Counsel
                         Lisa Epifani, Counsel
           Leon Lowery, Democratic Professional Staff Member

                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Bingaman, Hon. Jeff, U.S. Senator from New Mexico................     2
Cassidy, Frank, President and COO, PSEG Power LLC................    13
Johnson, Hon. Tim, U.S. Senator from South Dakota................    38
Silverstein, Evan J., General Partner, SILCAP Hedge Fund.........     9
Smith, Hon. Gordon, U.S. Senator from Oregon.....................     1
Smith, Suzanne G., Director, Corporate and Government Ratings, 
  Standard & Poor's..............................................    16
Sokol, David L., Chairman and CEO, MidAmerican Energy Holdings 
  Company........................................................    23
Svanda, David A., President, National Association of Regulatory 
  Utility Commissioners, and Commissioner, Michigan Public 
  Service Commission.............................................     3
Thomas, Hon. Craig, U.S. Senator from Wyoming....................     1

                               APPENDIXES
                               Appendix I

Responses to additional questions................................    45

                              Appendix II

Additional material submitted for the record.....................    57

 
             FINANCIAL CONDITION OF THE ELECTRICITY MARKET

                              ----------                              

                         TUESDAY, MARCH 4, 2003

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room SD-366, Dirksen Senate Office Building, Hon. Craig Thomas 
presiding.

   OPENING STATEMENT OF HON. CRAIG THOMAS, U.S. SENATOR FROM 
                            WYOMING

    Senator Thomas. Thank you for being here this morning. The 
purpose of this hearing is to take testimony on the current 
financial conditions facing the electric sector and to explore 
potential solutions, of course, to improve the financial 
challenges. I suppose the primary questions we will discuss are 
what caused the current financial situation in the electric 
industry? What are the effects of current financial conditions 
on the energy infrastructure? What remedies should we consider? 
And we will look forward to hearing from the witnesses.
    Very briefly, it seems to me that this is one of the real 
key issues that we have to deal with. Things have changed so 
much in the electric sector. We will be taking up hopefully an 
energy policy rather soon. I think that electricity should be 
part of that. It probably affects more people than any other 
aspect of energy. We have changed so much in terms of the 
method of generation and the transmission.
    So I have introduced, as matter of fact, an electric 
transmission and reliability bill that I hope will extend and 
open nondiscriminatory access, remove some of the antiquated 
statutory barriers that stand there, increase investment 
hopefully, and deal something with the transmission.
    So, Senator, do you have an opening statement?
    [The prepared statement of Senator Smith follows:]
   Prepared Statement of Hon. Gordon Smith, U.S. Senator From Oregon
    Mr. Chairman, I appreciate your willingness to put together this 
hearing to examine the financial condition of the electricity market.
    I must say from the outset, however, that while I am concerned 
about the financial condition of the electricity market, I am equally 
as concerned about the financial condition of electricity users. In the 
Pacific Northwest, we are still feeling the financial effects of the 
volatile electricity market of late 2000 and 2001.
    Most ratepayers in the Pacific Northwest have seen their power 
rates go up by at least 40 percent, and BPA has begun another rate case 
to raise rates again next October.
    Meanwhile, our energy intensive industries are shuttered, and 
Oregon continues to have the second highest unemployment rate in the 
country.
    I become very concerned when I hear people say that the goal for 
the wholesale energy market is competition. In my view, the goal is to 
keep the lights on for every American, at reasonable rates. Businesses 
from Main Street to Wall Street must also have access to reliable and 
affordable energy.
    I have read through the testimony of the witnesses before us today, 
and they outline the wide range of challenges facing electricity 
companies, particularly those with merchant plants or energy trading 
and marketing operations. These include: excess generating capacity and 
thin margins in parts of the country; extensive credit downgrades since 
2001; high levels of debt; the need to refinance tens of billions of 
dollars in debt; reduced demand; and continued regulatory uncertainty.
    I appreciate the suggestions made by the witnesses concerning the 
changes needed. As a new member of the Finance Committee, I will 
certainly review the proposals for changes in the tax code as well.
    What is clear to me, however, is that there is no ``silver bullet'' 
that will cure the myriad of ills facing electricity providers, 
particularly those with unregulated generation.
    In fact, in my view, these ``poor industry fundamentals,'' as they 
are referred to by the witness from Standard and Poor's, are also the 
result of regulatory and legislative uncertainty that has been going on 
for more than 10 years now. Beginning as far back as 1988, we have seen 
major proposed rulemaking regarding the electricity industry every two 
to three years. Congress passed the Energy Policy Act in 1992, and we 
have debated energy legislation for three Congresses now.
    We are still working through the proposed rulemaking on standard 
market design (SMD). As you know, I have opposed this rulemaking, 
because I believe it is unnecessary and unworkable, particularly in the 
Pacific Northwest. If there are instances of undue discrimination on 
the transmission system, I believe that the Federal Energy Regulatory 
Commission (FERC) has the ability, under Order 888 or in the 
development of tariffs for regional transmission organizations, to 
remedy such discrimination.
    I wonder how many members who voted for the 1992 Act, which was 
enacted before I began my service in the Congress, thought it would 
result ten years later in a 600-page proposed rulemaking on SMD. I only 
bring this up to illustrate that, as we contemplate additional 
legislation on electricity, I remain concerned that we are potentially 
extending for years--if not decades--the regulatory uncertainty facing 
the industry.
    I want to know what the impact of our actions will be on the end 
user, such as the family-owned grocery store in rural Oregon.
    In closing, Mr. Chairman, while I appreciate this oversight 
hearing, I would ask that any proposed electricity title be the subject 
of a legislative hearing before we proceed to mark-up. I believe it is 
important that we build the record on such important legislation, and 
fully understand the impact of proposed language before moving forward.
    I look forward to hearing from the witnesses today.

 STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW MEXICO

    Senator Bingaman. Thank you very much, Mr. Chairman. I 
think this is a very important hearing. I welcome all the 
witnesses. I know the focus of this hearing is on the financial 
condition of the electric industry. And clearly, that is an 
important issue to focus on. I also am going to have some 
questions and hope the witnesses will be able to give us some 
insights on the issue of supply and whether or not we are 
building the necessary capacity to meet the demand that is 
going to be there.
    I worry a little bit that some of the same circumstances 
that we saw leading up to the crisis in California and the 
Northwest with lack of hydroelectric power. All these issues 
seem to be back again. And, I know the issue of the financial 
condition of the industry and the issue of adequate supply are 
intertwined. I hope we can get into both a little bit in this 
hearing and then perhaps have a separate hearing on the supply 
issue.
    But thank you very much for having the hearing.
    Senator Thomas. Thank you, sir.
    Senator.
    Senator Campbell. Mr. Chairman, I have a conflict, like 
most of us do. So with your permission, I have a number of 
questions, some dealing with supply, as Senator Bingaman does. 
And I think, if it is all right with you, I would like to 
submit those to the witnesses and get some answers in writing. 
Most of them are general in nature. There are a few that are 
Colorado specific, however.
    Senator Thomas. Absolutely. We will do that.
    We are very pleased this morning to have Commissioner 
Svanda with us, the commissioner of Michigan PSC; Frank 
Cassidy, who is president and CEO of PSEG Power; Suzanne Smith, 
the director of Corporate and Government Ratings, Standard & 
Poor's; Frank Cassidy; and Evan Silverstein.
    We are delighted to have you, gentlemen. We will--I am not 
going to have an opening statement. If you can hold your 
testimony to 5 or 6 minutes, we would appreciate it. And then 
we will have some questions.
    So Commissioner, if you would like to begin?

 STATEMENT OF DAVID A. SVANDA, PRESIDENT, NATIONAL ASSOCIATION 
OF REGULATORY UTILITY COMMISSIONERS, AND COMMISSIONER, MICHIGAN 
                   PUBLIC SERVICE COMMISSION

    Mr. Svanda. Thank you, Mr. Chairman and members of the 
committee. I certainly appreciate this opportunity to speak 
before you. I am Dave Svanda. I am a commissioner in Michigan. 
I am also the president of NARUC, the National Association of 
Regulatory Utility Commissioners.
    I would like to supplement my written testimony. And I 
would like to supplement it with some broader and also with 
some more specific observations. The first of these is to go 
directly to the question that you asked first of all. And that 
is, what are the current financial realities?
    With respect to those financial conditions that we all care 
about, our statements, NARUC and Michigan, are virtually the 
same. Our views are the same. The analysis is the same. And it 
is consistent with all of the other commenters that we read 
comments from or hear from. And it is consistent in that we 
express that conditions are certainly not ideal today.
    However, this sector does not operate in a separate vacuum 
from the rest of the economy or from other capital markets. I 
mean, we need to view this sector in the context of those 
broader markets.
    On the system, demand is down. So the system is not being 
challenged today. This country has been on a capital investment 
starvation diet, especially with regard to transmission, for 
about two decades. Transmission transfer capacity, in fact, 
peaked in the 1980's. Reasonable estimates are that we need 
something north of $55 billion invested in electric 
transmission upgrades alone, never mind the other components 
and never mind other related cornerstones, such as gas 
transmission.
    Transmission assets are in fact bedrock American 
infrastructure investments and should be acknowledged by all 
for what they are. My written testimony provides very concrete 
examples of what great investments in transmission happen to be 
today.
    In many respects, this country's transmission system is a 
dumb, mechanical switch system from the last century. Our 
investment incentives, our focus for the future, should be 
guiding us to an Internet smart and Internet speed type of grid 
to help us maintain our position of world leadership.
    National average headline conditions do not really reflect 
the true on-the-ground electricity demand and supply 
conditions, as we experience them out in the States. Load 
pockets today are in fact crying for investment, but those 
cries are drowned out by headlines of national generation gluts 
and other circumstances. Investors really need help in seeing 
the trees in the forest.
    Let me turn to my next topic, and that is incenting 
investment. Recognizing that there are some global 
uncertainties that affect all of our thoughts, there are still 
methods for opening the investment spigot. Those policies that 
should be pursued, I believe, incent investment that help us to 
accomplish other major national objectives.
    The first would be to focus on customer needs and incent 
investment to enhance reliability, to support the information, 
manufacturing, and lifestyle practices of today, and to incent 
investing to remove bottlenecks. And I would suggest here a 
carrot and stick approach, that we in fact provide incentives 
for the removal of bottlenecks where they exist in the 
transmission system. And to the extent that the incentives of 
the carrots are not taken up, that stick be applied. And that 
stick would be penalties for those who own bottlenecks. And 
those penalties may apply after two or three years of 
congestion season ownership of those bottlenecks.
    I think there should be a focus on technological 
advancement, incent investing on new smart, good technologies 
that exist today, but have simply not been rolled out in any 
major fashion. We could certainly export those technologies, 
both for our economic benefit and for global fuel efficiency 
purposes.
    We need to focus on a balanced fuel portfolio and demand 
response mechanism, including those fuel sources that are most 
abundant on this continent, and I would note clean coal 
technology specifically. We need to focus on maintaining 
America's competitive advantages and fostering wise North 
American continental energy utilization and, lastly, focus on 
enhancing national security. The American public and the 
investing public would certainly understand these types of 
investment incentive objectives.
    Let me speak briefly to restoring confidence or 
specifically corporate structure. Recent U.S. corporate history 
has taught most of us that it is important to have access to 
understandable, credible, ethically correct transparent and 
accurate financial information. Altering the allowed 
relationship between a public utility and its holding company 
parent should only be undertaken in a manner in which respects 
our recent history lesson and applies what it has taught us.
    Examples of parent-induced problems are plentiful. I would 
be happy during question and answer or on follow-up to discuss 
details of which I am all too painfully aware with respect to 
this and if you have interest.
    Let me summarize by saying that there are huge unmet 
electricity, and in fact energy generally, infrastructure 
demands. Investment is required for national security, for 
reliability, for replacing old and outdated technology, to feed 
and then sustain this country's economic recovery, to enhance 
fuel diversity and energy conservation, and to give U.S. 
customers the energy options that they need.
    U.S. infrastructure is a stable investment and compares 
very favorably when you measure its returns against most 
indices available today. Investment options will generally fall 
into four categories. First will be the traditional public and 
IOU-type utilities; second, unbundled asset utilities; third, 
independent power producers; and fourth, transmission. All of 
these have their place. They are all right for particular 
circumstances.
    A balanced strategy would include investment in each. A 
balanced investment incentive program crafted by this committee 
would give equal weight and value to each of these categories.
    Thank you. And I look forward to your questions.
    [The prepared statement of Mr. Svanda follows:]

Prepared Statement of David A. Svanda, President, National Association 
of Regulatory Utility Commissioners, and Commissioner, Michigan Public 
                           Service Commission

    Thank you Mr. Chairman and Members of the Committee for this 
opportunity to share my perspectives with you on the financial 
condition of the electricity market and some suggestions I would offer 
to improve it. I am David A. Svanda, President of the National 
Association of Regulatory Utility Commissioners (NARUC) and a 
Commissioner on the Michigan Public Service Commission. I respectfully 
request that NARUC's written statement be included in today's hearing 
record as if fully read.
    NARUC is a quasi-governmental, nonprofit organization founded in 
1889. Its membership includes the State public utility commissions for 
all States and territories. NARUC's mission is to serve the public 
interest by improving the quality and effectiveness of public utility 
regulation. NARUC's members regulate the retail rates and services of 
electric, gas, water and telephone utilities. We have the obligation 
under State law to ensure the establishment and maintenance of such 
energy utility services as may be required by the public convenience 
and necessity, and to ensure that such services are provided at rates 
and conditions that are just, reasonable and nondiscriminatory for all 
consumers.
    Energy drives our economy and indeed our entire society. Yet today, 
our energy markets are in turmoil. This turmoil may eventually 
undermine the country's economic recovery and future economic growth, 
unless we develop and pursue policies that restore confidence and open 
the capital spigot of this nation. These policy objectives need to 
provide stability and consistency, and in so doing, will promote the 
confidence necessary for renewed investment in our energy 
infrastructure.

       I. CURRENT FINANCIAL CONDITIONS FACING ELECTRICITY SECTOR

    The last two years have been among the most turbulent periods in 
the history of the electricity business in the United States. While 
investor confidence is lacking in the economy as a whole, these last 
two years in the electric industry have undermined the stability of the 
nation's energy markets, by shaking investor's confidence in the 
electric industry as a long-term investment and seriously eroding the 
liquidity necessary for the performance of efficient markets. According 
to the Electric Power Research Institute (EPRI), the electric 
industry's credit situation is the worst in over 70 years, with half 
the industry rated below investment grade. Today, a limited number of 
banks are controlling the lending market at a time when $25 billion 
needs to be refinanced in 2003 alone. The equivalent of one year's 
electric industry revenues, $250 billion in market capitalization, has 
been lost to the industry. The equity value of the merchant power 
sector alone has dropped from $145 billion to under $10 billion. The 
combined capital expenditures of regulated and deregulated electricity 
companies, as a fraction of their revenues in the 1990s, was 12%. This 
is half the expenditure rate during the Depression and World War II. 
The electricity industry is almost last among the 53 largest U.S. 
sectors in terms of investment in infrastructure technology 
development.
    Paradoxically, the industry is struggling with an oversupply of 
generation, in some regions, that has depressed wholesale power prices 
and further weakened generator finances. I have heard disheartening 
words from utility executives trying to describe an operating and 
business environment that they have never experienced.
    Some of the nation's first attempts to restructure an industry that 
has remained essentially unchanged for nearly a century have produced 
some regrettable headlines, but have also revealed the vast 
opportunities that market restructuring can offer. In Michigan, we did 
a back-of-an-envelope calculation of the cost to Michigan ratepayers of 
continuing to have a constrained transmission system, versus an open 
access transmission system. With open access, Michigan customers could 
save from 5-15 percent on their energy bills. This represents hundreds 
of millions of dollars of potential savings to Michigan customers. To 
tap these potential savings, investments to alleviate transmission 
constraints must be made. Load pockets throughout the United States 
would benefit from additional generation investment or transmission 
expansion, and in fact represent excellent investment opportunities for 
savvy investors.
    The price of doing nothing is instability, uncertainty and lost 
opportunities to use our resources wisely. These are characteristics 
that can only serve to depress further investment in this critical 
industry. Bringing clarity and certainty to the manner in which 
electricity services are provided in this country will go a long way 
toward settling the investor jitters so evident today.

       II. POLICY GOALS THAT PROMOTE CONFIDENCE IN ENERGY MARKETS

A. Regional nature of electricity markets
    Most critically, it must be recognize that electricity markets have 
developed based on regional differences. These regional markets have 
different population densities, unique transmission system 
characteristics, disparate local fuel sources, differing dispatch 
protocols and generation ownership. These all reflect unique regional 
characteristics of geography, and economic development.
    FERC has recognized that there is not just one energy market in the 
country, but rather linkages between distinct regional markets. State 
regulators and others have taught this to FERC and also recognize the 
regional nature of electricity flows, siting needs, and transmission 
expansions and additions. NARUC along with the National Governors 
Association, regional Governors associations, FERC and others have been 
perfecting multi-state entities (MSE) to maximize the efficiency of the 
approval process for the implementation of infrastructure improvements. 
We have been collectively working with the Department of Energy to fund 
the creation and development of these regional organizations. We 
believe these regional organizations will be important for 
communications, coordination, and for building confidence between 
state, regional and federal industry agencies.
    In the past, a state needed regional ties to improve the 
reliability of its electricity service, to help a state with a 
localized supply problem. Now, beyond reliability, states need strong 
regional ties to survive economically in the global market place.
    Finance and regulation are no strangers to regional markets. Oil 
and gas production have long been associated with the Gulf area. The 
Midwest is known for its automobile production infrastructure and 
expertise. Aluminum production is the pride of the Northwest. However, 
investors will shift their investment philosophy from national to 
regional opportunities in the electric industry only if the uncertainty 
in the electricity market can be resolved by evidence of regional 
cooperation in critical areas. Policy makers at both the federal and 
state levels can encourage this investment policy shift by promoting 
and pursuing regional markets and policies.

B. Complementary regulatory practices
    Next, consistent federal and state policies that support investment 
in energy infrastructure must continue. Complementary policies serve as 
the cornerstone for promoting consistency that is necessary to build 
confidence in the energy industry. These policies can lead to standard 
business practices that all industry participants can rely on. At the 
same time, they are critical to providing transparency and reducing 
market risks.
    My own home state of Michigan provides an example of how such 
policies can induce investments in electricity infrastructure markets. 
Our two largest electric utilities were formerly fully integrated, 
owning generation, transmission, and distribution facilities. Recently, 
these two Michigan utilities have unbundled, or have chosen to divest, 
not their generation, but their transmission assets to non-affiliated 
entities. Trans-Elect and Kohlberg Kravis Roberts (KKR), the purchasing 
companies, are pursuing a competitive business model for transmission 
additions and expansions in a business environment with consistently 
supportive federal and state policies.
    The purchase of the Consumers Energy transmission system by Trans-
Elect was the first outright sale of a U.S.-based transmission system 
to an independent transmission company. It was also the first time FERC 
approved such a sale. The combination of FERC's strong endorsement of 
the Trans-Elect business model, the ability of Trans-Elect to function 
within the business standards adopted by the Midwest Independent System 
Operator, FERC's first qualified RTO, and the support of Michigan 
regulatory and legislative policy permitted Trans-Elect to bring the 
complicated transaction to a successful close. Moreover, this business 
deal has created a solid foundation for future transactions. The sale 
was worth approximately $290 million.
    At the end of last year, DTE Energy (DTE) announced that it was 
selling its transmission subsidiary, the International Transmission 
Company, to affiliates of Kohlberg Kravis Roberts for about $610 
million. This business decision was made in part because of consistent 
federal regulatory policy and Michigan law, both of which promote the 
independent operation of the electric transmission grid within the 
footprint of our regional transmission operator, the Midwest 
Independent System Operator.
    DTE specifically commented on the foresight of the FERC and the 
Michigan Commission in creating a regulatory structure that supports a 
more competitive and efficient U.S. power industry. KKR is also looking 
forward to pursuing additional transmission opportunities as other 
utilities follow this investment trend. In both of these transactions, 
the gains from the sale were split 50/50 between the selling utilities 
and their ratepayers.
    It is interesting to note that both of these transmission sales, 
almost one billion dollars of new investment, were made possible in 
part because of consistent state and federal policies that encourage 
participation in the new regional Midwest Independent System Operator 
(MISO). The stability of regional open access rules and the promise of 
transparent and vibrant Midwest transmission markets no doubt 
encouraged investors to commit substantial capital to an otherwise 
stagnant utility sector. Several other transmission owning MISO 
participants have also committed to additional transmission 
construction that probably would not have occurred without the 
establishment of this FERC approved regional transmission organization.
    Early on in the electricity restructuring saga Michigan realized 
that retail markets can only flourish if there is a vibrant regional 
wholesale market and have chosen this path as part of our state's 
economic development program. Although some of the other Midwest states 
have not embraced retail choice, they still benefit from and support 
participation in the MISO wholesale market.
    A very positive development in supporting federal and state 
regulatory practices involves the common interest and cooperation in 
market monitoring. I don't need to describe the malaise created in 
California markets just a couple of years ago. What I want to highlight 
is the joint efforts of the federal government and states, working 
though regional organizations like the PJM and MISO, to prevent future 
market abuses. In doing so, much uncertainty has been removed from the 
markets and important steps have been taken to rebuild confidence in 
the fair and efficient operation of the nation's energy markets.

C. State regulatory environment
    As a public utility Commissioner, I would be remiss if I failed to 
identify the significant influence that state utility regulatory 
commissions have with respect to energy investment decisions. A stable 
regulatory environment, characterized by fair and balanced oversight of 
utility operations, along with well-targeted incentives, can go a long 
way to encourage a supportive climate for investors within a state.
    Consistency is the hallmark for regulatory stability. Decision-
making processes and approaches should be transparent and clearly 
understood so investors understand the ground rules and are able to 
effectively evaluate and assess the risks and rewards of conducting 
business within the state's jurisdictional purview. Abrupt and 
precipitous changes should be avoided, except under the most compelling 
circumstances.
    Decision-making should be balanced, rewarding good performance as 
well as penalizing poor results. I firmly believe that an increased 
role for regulatory incentive initiatives is needed. Additionally, I am 
convinced the reward side of the regulatory equation to influence 
decisions is significantly underdeveloped. Greater reliance on the 
carrot approach is a tool in the regulatory kit that offers great 
potential to attract the investment community. The sharing of net 
proceeds from the transmission asset sales of Michigan's two large 
investor owned utilities discussed above is a specific example of how 
application of incentives can encourage decisions favorable to the 
investors, while accomplishing state and federal competitive policy 
goals relating to transmission independence. Likewise, securitization 
financing of stranded assets was a key factor encouraging Michigan 
utilities to agree to open their markets to competition, an initiative 
very positively received by Wall Street. Securitizing investment in 
strategic new investments may also be an attractive inducement to 
invest.
    Though some states in some regions have questioned FERC's policy of 
encouraging investment in transmission assets by providing investment 
incentives and NARUC has taken no position on FERC's policy, I support 
it. FERC has come to the same conclusion that we in Michigan have come 
to, that there are advantages to well designed incentives. Incentives 
may improve efficiency and if done properly can be a good tool to 
encourage investment.
    Working cooperatively with sister state and local agencies that 
exert influence over energy investment decisions is another way states 
can improve the investment environment. Fertile areas for coordination 
include siting, permitting, safety, economic development, and taxation. 
I am convinced that a strong cooperative effort among Michigan state 
and local agencies and stakeholders played a significant part in the 
several thousand megawatts of merchant plant generation brought on in 
Michigan over the past three years. In particular, I am pleased with 
the considerable Commission effort extended to working with merchant 
generation developers to help communicate the importance of these 
facilities to the State, in particular speaking to energy reliability 
and the State's competitive position as a place to conduct business.
    With respect to the influence of state regulation on the energy 
investment environment, no discussion would be complete without mention 
of regulatory lag. Tardy recovery of prudent investment costs is 
troublesome to investors. There simply is no way to present regulatory 
lag in a positive light on that score. Unfortunately, while it may not 
be legally possible to eliminate the temporal distance between cost 
incurrence and recovery, increased focus and attention to substantial 
reduction should be considered as an option with substantial potential 
to strengthen the investment climate. Examples of efforts in Michigan 
to address this issue include a time deadline for Commission decisions 
in utility rate cases and responsive initiatives for electric fuel and 
power purchases and gas commodity cost recovery through variable 
monthly supply surcharges. Securitization of certain utility assets, 
discussed above, is another example. Other opportunities should be 
explored as well.

D. Public Utility Holding Company Act (PUHCA)
    Traditional sources of capital have moved away from the electricity 
industry. However, there are potential investors that apparently are 
not considering investment because of PUHCA. Congress should reform 
PUHCA. However, in doing so should allow states to protect the public 
through maintaining effective oversight of holding company practices 
and expanding state access to holding company books and records, 
independent of any similar authorities granted to the federal 
regulatory bodies.
    Access to books and records required to verify transactions 
directly affecting a companies regulated utility operations is of vital 
importance to state commissions. Requests for such books and records by 
a commission, its staff, or its authorized agents should be deemed 
presumptively valid, material, and relevant, with the burden falling to 
the company to prove otherwise.
    FERC and the states ought to be given greater access to corporate 
documents to conduct investigations into financial dealings. Each time 
statutory exemptions were made to PUHCA, safeguards to protect utility 
consumers were included. Enhanced state and federal access to data and 
information will provide consumer protection safeguards in an 
environment without the PUHCA safety net, while promoting investment.

E. Promotion of Efficient Generation Technology
    Renewable energy sources such as biomass, geothermal energy, wind 
and solar power make up 4 percent of U.S. energy production. A diverse 
generation portfolio provides the best assurances for a secure energy 
future and, yet, investment in renewable sources has remained low.
    An increase in tax incentives for investments in renewable 
technologies would allow for a greater penetration of these sources in 
the U.S. energy market. Section 45 of the Internal Revenue Code 
currently provides the owners of wind facilities, closed-loop biomass 
facilities, and chicken waste facilities a production tax credit for 
each kilowatt-hour of electricity generated by those facilities. Such a 
credit has been instrumental in the development of the wind generation 
industry, providing the essential boost for this developing technology. 
The extension of the production tax credit to other renewable sources 
will promote the development of these emerging technologies.

                            III. CONCLUSION

    The economic prosperity that we enjoy as Americans has been fueled 
by energy. Energy has fueled our evolution through agricultural 
development, through our industrial transformation, and into our 
premier status in the global economy. The nation's continued economic 
growth, indeed our national security, depends on the efficient 
operation of energy markets. Though these markets are facing some of 
the most turbulent times since the industry's infancy, there are 
important steps that we can take to the restore confidence of all 
market participants in the fair and efficient operation of these 
markets. These steps include: (1) recognizing and working with the 
regional nature of the energy markets; (2) encouraging complementary 
federal, regional, and state regulatory practices; (3) working as state 
regulators to exercise balanced decision making, providing the right 
incentives, and working cooperatively among ourselves and our national 
colleagues to provide a stable market with consistent rules; (4) 
reforming PUHCA in a manner that allows the states to protect the 
public and provide needed transparency; and (5) provide tax incentives 
to promote greater development and use of renewable energy. I am 
convinced that these policies can help build confidence of investors, 
consumers, utilities, and other market participants in our energy 
markets.
    Thank you for your attention. I look forward to answering any 
questions you may have.

    Senator Thomas. Okay. And thank you, sir.
    Mr. Silverstein.

STATEMENT OF EVAN J. SILVERSTEIN, GENERAL PARTNER, SILCAP HEDGE 
                              FUND

    Mr. Silverstein. Thank you. As you know, my name is Evan 
Silverstein. I am the general partner and portfolio manager at 
SILCAP, L.L.C., a market neutral hedge fund that principally 
invests in utility and energy companies. I want to thank this 
committee for inviting me here today so I can provide 
perspective on the current status of the energy industry and 
why are we in this position and what we can do to help 
transition to a more constructive framework.
    I have spent almost 28 years, my entire professional 
career, specializing in the utility/energy industry, dating 
back to 1975. In my role, I have constantly evaluated macro- 
and micro-economic, political, and sociological trends in 
assessing the investment attractiveness of the industry and its 
companies. As a result, I would like to view myself as an 
expert, a student of the industry, and feel a strong sense of 
emotional attachment.
    While my professional role is to evaluate these issues and 
make the correct investment decisions, to me that is less 
important than helping mold the more constructive atmosphere 
for energy policy.
    I would like to summarize my testimony in the following 
points: It is critical that we develop a comprehensive energy 
plan that encompasses environmental and tax policy. This is the 
only way to create an environment that provides for capital at 
reasonable cost and availability to support infrastructure 
development. Anything short of that can endanger our ability to 
achieve low cost energy independence. I do not want to downplay 
the significance of what has happened over the past few years. 
But I am very concerned that, based on history, we may 
overreact to the short run and not stay focused on the more 
important issue of establishing policy for long run 
development. We need to take lessons learned from the past few 
years to improve future market structure.
    Since 1975, when I entered the industry, fuel shocks, 
nuclear crisis, gas restrictions, PURPA have all served to 
produce financial stress and political and regulatory responses 
that were overreactions, that sacrificed constructive long-term 
policy development. Our energy and environmental policy has 
been in a state of flux for too long. We need some stability 
and certainty in our policy in order to attract reasonably 
price capital.
    High anxiety and uncertainty are the chief causes of 
capital dislocation. We have to decide what our social 
objectives are and agree that a policy that obstructs building 
transmission pipelines, the use of coal and nuclear, and 
drilling for new natural gas is less of a policy than just say 
no.
    Certainly the development of renewables, clean coal 
technology, hydrogen-based solutions and conservation are all 
part of the future. But they are not ready to carry the load. 
Recent stresses in natural gas are indicative of infrastructure 
shortcomings. We have to find a way to integrate State and 
Federal needs into a common goal. We need to complete our 
investigations as soon as possible. We need to move forward.
    To be sure, many factors contributed to the current crisis. 
The 1990's were a euphoric environment that produced large 
amounts of cheap and undisciplined capital. Industry, such as 
merchant energy, technology and telecommunications, were 
unfunded, which resulted in significant excess capacity. 
Moreover, the extensive use of leverage, a declining economy, 
and an unprecedented credibility crisis produced a severe 
liquidity and capital crisis in the industry.
    Greed was another characteristic of the 1990's. And this 
human trait, combined with questionable ethical and legal 
behavior, contributed to the collapse of the merchant and 
trading business. However, while competitive model has been 
damaged, I do not believe it has failed. In my view, the 
California model of forcing electricity into the spot market 
without ability to contract bilaterally was its fatal flaw.
    Competitive markets are operating and developing in other 
parts of the country. Nevertheless, the market development is 
being hindered by the need for the development of some kind of 
independent transmission model that provides credibility and 
sends the right economic signals. I believe transmission should 
be independent under any model adopted.
    A combination of market forces and properly incented 
regulatory structures are ideal. We cannot judge the success of 
any model by whether prices are going up or down. Whatever 
model we adopt is supposed to produce the most sufficient price 
at this point in time to meet short- and long-term needs, 
including capital investment.
    The industry certainly needs to be monitored more closely, 
have some sort of regulatory oversight, and provide significant 
penalties for abusers. But we have to be careful not to over 
regulate. We need to allow market forces to drive good decision 
making and allow development of creative and ingenious 
solutions to our energy problems.
    In this regard, PUHCA needs to be reformed to allow for 
consolidation that is not in conflict with market power issues 
and allow for the injection of fresh capital. Consolidation is 
a natural response to financial stress.
    Finally, we need fuel diversity. Every time in history when 
we have relied on one single fuel source for incremental needs 
it has been quite a mistake. Diversification is the key to 
long-term energy management.
    The last few years have been characterized by severe 
dislocation. Nevertheless, if we do not focus on incorporating 
on the lessons learned into the future policy and structure, 
the pain went for naught. Our economic prosperity and perhaps 
national security is dependent on our ability to move forward.
    I hope this hearing signifies the beginning of this 
process, because we need to succeed.
    [The prepared statement of Mr. Silverstein follows:]

      Prepared Statement of Evan J. Silverstein, General Partner, 
                           SILCAP Hedge Fund

    As you know, my name is Evan J. Silverstein. I am the general 
partner and portfolio manager for SILCAP LLC, a market neutral hedge 
fund that principally invests in utilities and energy companies. I want 
to thank this committee for inviting me here today so I can provide 
perspective on the current status of the energy industry, why we are 
here, and what can we do to help transition us to a more constructive 
framework.
    I have spent almost 28 years--my entire professional career--
specializing in the utility/energy industry dating back to 1975.
    In my role, I have constantly evaluated macro- and micro-economic, 
political, and sociological trends in assessing the investment 
attractiveness of the industry and its companies.
    As a result, I would like to view myself as an expert student of 
the industry to which I feel a strong sense of emotional attachment. 
While my professional role is to evaluate these issues and make the 
correct investment decisions, to me that is less important than helping 
mold a more constructive atmosphere for our energy policy.
    Clearly, the energy industry is in a state of crisis at a 
particularly vulnerable time for our country. I believe it is 
imperative that we put aside self-interests and develop a cohesive 
energy, environmental, and tax policy in order to create a stable and 
more certain environment for energy investment.
    Low cost energy and independence has been one of the great 
underpinnings of this great country, and I am concerned we are in 
danger of losing that advantage. As I will discuss later, I do not want 
to downplay the seriousness of events over the past few years that 
included unethical and possibly illegal behavior on the part of some 
industry participants. However, I'm very concerned that if we fixate on 
those issues, we may lose sight of the more important issue of 
developing a long term structure for energy investment. The tendency to 
overcorrect for the most recent problems starts us on a trend that 
creates other obstacles down the road. I have seen it happen before. 
While the specifics of each crisis may be different, we have been here 
before.
    In 1975, when I first came into the industry, it was facing severe 
dislocation as result of oil and gas fuel shocks. A handful of 
companies were on the brink of bankruptcy and capital was tight and 
expensive. Our response was to eliminate the use of natural gas for 
electricity production and promote the development of nuclear power.
    With runaway inflation and oil prices expected to exceed $50 a 
barrel, nuclear was supposed to be our path to energy independence. 
However, lax oversight in the construction and operation of these 
facilities, highlighted by the Three Mile Island accident, led to the 
shutdown of the construction of these facilities in midstream and, once 
again, created severe financial crisis that led to major write-offs, 
some bankruptcies, and significant excess capacity.
    We then decided that nuclear was not such a good idea. We imposed 
tremendous safety requirements as a reaction to the problems and 
effectively made nuclear a stranded asset. With fuel prices subsiding 
and gas now in oversupply, we removed restrictions on gas for electric 
generation and identified that as our environmentally preferred fuel. 
We also implemented PURPA, which was supposed to promote the 
development of the independent power industry.
    We developed pricing umbrellas theoretically based on avoided cost, 
but in reality wound up being overstated, resulting in another layer of 
significantly above-market stranded costs that needed to be addressed. 
In almost all these periods, the response to the most recent crisis 
created an overreaction that led to additional inefficiencies.
    I am very concerned that we are in that very position today and 
it's what we need to avoid. The factors that have put us in the current 
crisis consist of macro, micro and psychological forces that came 
together to produce somewhat of a perfect storm. The 1990's were 
generally a euphoric environment for this country which led to the 
existence of cheap and easily available capital. This led to an 
unprecedented investment in merchant plants with little assessment of 
the risks involved. The expectation was that growth would continue 
unabated and every plant would be needed and produce attractive 
returns. The more companies invested, the higher there stock prices 
rose.
    At the same time, another phenomenon was at work. The pressure to 
show earnings growth was severe across the entire stock market and the 
use of undue leverage became more and more prominent, especially since 
investors, fixed income analysts and even rating agencies did not seem 
to object. As these conditions were reaching their heights, industry 
conditions began to change. The failed deregulation experiment in 
California which led to runaway prices, the unethical and perhaps 
illegal behavior of certain market participants, the significant 
failure of many companies, overbuilding and a significantly weakening 
economy has created a credibility crisis that has effectively shutdown 
reasonable cost capital to the industry and promoted a liquidity crisis 
in some cases.
    A significant pullback on the part of the banks because of 
overexposure to the merchant industry and the tremendous risk aversion 
on the part of investors have made capital availability way too tight 
and costly.
    While I do not condone unethical or illegal behavior, we should not 
be surprised by what has happened. Most of it has been driven by the 
human trait of greed. Greed on the part of investors expecting to make 
easy money in the stock market, greed on the part of market 
participants who saw an opportunity to take advantage of market 
dislocations and inefficiencies and greed on the part of company 
managements trying to drive up stock prices to get rich. We all 
contributed in some sense.
    While capital to the merchant industry is clearly limited, capital 
for infrastructure development is available as long some certainty 
exists. Infrastructure-type assets like pipelines and transmission are 
already changing hands and integrated energy companies that are 
financially strong and are not overwhelmed by merchant issues can raise 
capital on somewhat reasonable terms. Nevertheless, the uncertainty 
surrounding our energy and environmental policies at both the state and 
federal levels continues to be an issue and there is nothing that 
raises the cost of capital more than uncertainty.
    When I think of how to remedy this situation, I submit that we have 
to make a strong commitment to developing a comprehensive solution that 
includes energy, tax and environmental policy. This cannot be 
piecemeal. We have to decide what our social objectives are and make it 
clear that a policy that does not allow for the building of 
transmission and pipelines, the use of coal and nuclear, and new 
drilling for natural gas is less of policy than a ``just say no'' 
approach.
    Certainly, the development of renewables, conservation, and 
technological development of things like clean coal technology, all 
have a place in our future but will have to evolve and are not yet 
ready to carry the entire load. What we need is certainty and 
visibility. We need to commit to a plan that is agreed upon by all 
political factions such that it has staying power. To be sure, whatever 
is adopted may be modified over time as we learn from experiences, but 
we need to avoid radical shifts dominated by political influence.
    Our ability to achieve this is even more challenged in electricity 
because of the constant state-versus-federal conflicts, but these need 
to be overcome to achieve a must-needed solution to a critical issue 
for our economy and society. We have to avoid the temptation of 
overcorrecting for recent problems and stay focused on long-term 
solutions. We cannot say a model is working only when prices are low 
and it is broken when prices are up. Any model is designed to achieve 
the most efficient price at any point in time to provide for short- and 
long-term needs, including capital investment.
    In that regard, in my view, while the wholesale deregulated model 
has been damaged and is in need of change, it should not be discarded. 
While the California model failed, flaws in that model, primarily 
forcing all the power into the spot market and not allowing for 
contracting, were prime contributors to that failure. There are other 
places in the country such as Texas, PJM, New York, New England, etc. 
where models are working and continue to improve.
    Nevertheless, one of the great failures of our move towards a 
deregulated model is that we did not solve our transmission problem 
prior to supporting major expansion in merchant capacity. I think this 
kind of thinking is also showing up in natural gas today. We promoted 
the growing use of natural gas for power generation but did not provide 
for the infrastructure needed to support this growth. Thus, with 
production declining and usage increasing, we are starting to see 
significant stresses.
    In my view, both from a credibility and economic standpoint, 
transmission needs to be truly independently operated in order to avoid 
conflicts of interest and to send the right economic signals. I believe 
this is true under any model ultimately adopted. While clearly the 
trading of electricity needed to be monitored more closely and subject 
to some kind of oversight, we need to assure we do not overregulate. We 
need to allow for the development of market forces to drive good 
decision making and allow the development of creative and ingenious 
solutions to our energy problems.
    We should not prescribe solutions, but set good policy with proper 
incentives and allow the markets to work. In this regard, we need to 
examine PUHCA, which is an antiquated structure and at the very least 
allow for changes that would promote consolidation and the injection of 
fresh capital into the industry, which undoubtedly should be part of 
the rebuilding process.
    My final point deals with the need to diversify fuel sources. In my 
28-year history, anytime we have relied on one single fuel source to 
meet our incremental needs it has been a mistake. My recount of the 
past 28 years earlier should indicate that. We are starting to see the 
problems with our gas reliance right now even with a weak economy. Coal 
and maybe even nuclear has to be part of the mix.
    Thank you for your time. This hearing itself is indicative of you 
sharing my view of the importance of establishing a cohesive energy 
policy. In these difficult times with tremendous uncertainty and 
anxiety, we have to ensure we preserve our energy independence. We need 
certainty, stability and visibility to bring capital back to this 
industry on reasonable terms. I am hopeful we all can agree we need to 
get this done.

    Senator Thomas. Thank you very much.
    By the way, I did not mention your full statements will be 
put in the record.
    Mr. Cassidy.

        STATEMENT OF FRANK CASSIDY, PRESIDENT AND COO, 
                         PSEG POWER LLC

    Mr. Cassidy. Thank you, Mr. Chairman. I am Frank Cassidy. I 
am president and chief operation officer of PSEG Power, which 
is located in Newark, New Jersey, and is a subsidiary of Public 
Service Enterprise Group, a diversified energy company, which 
is celebrating its 100th anniversary this year.
    We are located within the PJMN interconnection, one of the 
Nation's largest and most successful competitive energy 
markets. And in addition to New Jersey and the PJM region, PSEG 
Power also has generating assets in operation or construction 
in New York, Connecticut, Ohio, and Indiana. I am pleased and 
honored to appear before this committee this morning to 
represent my company and the Electric Power Supply Association, 
or EPSA, which I currently chair.
    Mr. Chairman, as you are aware, there is a constant need 
for capital to run our day-to-day operations, build new 
facilities, and develop new technologies. Many companies, even 
those that are prudently managed and producing excellent 
operating results, are facing severe limitations on their 
ability to access capital. This is a serious problem and the 
one that must be addressed today, if we are to build the 355 
gigawatts of new electric capacity that the Department of 
Energy says we need by 2020.
    The turbulence in our industry already has caused companies 
to cancel or postpone development of approximately 53 gigawatts 
of new capacity. And while not all of these cancellations can 
be blamed directly on the credit crunch, I am very concerned 
about the impact tomorrow of the financial difficulties facing 
us today.
    I would like to briefly offer my thoughts on what 
conditions have contributed to today's difficulties, as well as 
what I view as necessary action on the part of industry and 
government to initiate recovery.
    First and most importantly, we need to recognize that 
today's credit crisis is partly the result of a sluggish 
economy which has reduced the demand for electricity.
    Second, part of our problem is self-inflicted. It would be 
disingenuous not to acknowledge that accounting difficulties, 
accusations of price manipulation, and inaccurate financial 
reporting have contributed to the lack of confidence now being 
expressed by financial markets and the financial community. The 
actions of a minority have affected the entire sector.
    Clearly, our industry must take the lead in restoring 
confidence of investors, regulators, policy makers, and 
customers in our industry and in the value of competition in 
electric markets. We are moving aggressively to restore 
confidence on an industry-wide basis by implementing the EPSA 
code of ethics and through the work of the committee of chief 
risk officers.
    On a company-by-company basis, we are shoring up our 
balance sheets, reducing debt levels, and making sure we live 
by the new Sarbanes-Oxley requirements. These efforts are 
essential, and they will continue.
    The third and final part of the problem involves continued 
uncertainty about the outcome of the public policy debate on 
the future of our industry. This committee has asked what 
Congress can do to help remove barriers to the flow of capital. 
I think there are four areas on which Congress can and should 
focus.
    First, Congress can help address regulatory uncertainty by 
enabling FERC to move promptly to established well-designed 
regional electricity markets across the country. In my view, 
the minimum requirements for a well-designed market include an 
independent grid operator, a real-time spot market with a means 
for managing congestion, a minimum resource adequacy 
requirement, and a market monitoring plan to assure that all 
participants obey the rules.
    Second, Congress needs to address the current patchwork of 
State and Federal environmental regulations for powerplant 
emissions. I am pleased that this topic is on the congressional 
agenda. And I encourage Congress to enact multi-pollutant 
legislation this year. This system will provide clear direction 
on environmental basis and a sound basis on which to make 
investment decisions about our facilities.
    The third issue Congress needs to address is reform of the 
bankruptcy code. One of the realities of the credit crunch is 
that some companies will likely face bankruptcy. Our industry 
has done a very good job in mitigating counter party risk by 
negotiating netting provisions and standard contracts. It is 
important that Congress pass bankruptcy reform legislation that 
ensures that these contract netting provisions are honored in 
bankruptcy proceedings.
    Finally, I would suggest two changes to the tax code that I 
believe will help spur investment. The first is accelerated 
depreciation of generation assets. Companies that build 
powerplants should be provided the same treatment as other 
capital-intensive industries.
    And for any publicly traded company like PSEG that pays 
dividends, elimination of the double tax would be a useful and 
important investment incentive. I realize this is a 
controversial component of the President's economic plan. And I 
hope that the debate focuses on the merits of the proposal, and 
it goes forward.
    Mr. Chairman, competitive power suppliers are responsible 
for 80 percent of oil generation capacity added in the past 
decade. It is very important that we address the financial 
condition of the electric industry now in order to assure that 
our Nation continues to be served by reliable, affordable, 
secure, and environmental responsible supplies of electric 
energy.
    Thanks for this opportunity. And I will be pleased to 
respond to your questions.
    [The prepared statement of Mr. Cassidy follows:]

 Prepared Statement of Frank Cassidy, President and COO, PSEG Power LLC

    I am Frank Cassidy, president and chief operating officer of PSEG 
Power LLC, based in Newark, New Jersey. My company is a competitive 
power supplier and a subsidiary of Public Service Enterprise Group, a 
diversified energy company which this year is celebrating its 100th 
anniversary. We are located within the PJM interconnection, one of the 
nation's largest and most successful competitive energy markets. In 
addition to New Jersey and the PJM region, PSEG also has generation 
assets in operation or construction in New York, Connecticut, Ohio, and 
Indiana.
    I am pleased and honored to appear before this Committee this 
morning to represent my company and the Electric Power Supply 
Association.
    I want to thank Chairman Domenici and Senator Bingaman for their 
foresight and leadership on issues affecting the energy industry. We're 
here today to explore the serious financial challenges my industry now 
confronts. To put this problem in some kind of context, I've worked in 
the electric industry my entire career--more than 30 years. The 
financial conditions we are experiencing now are the most difficult 
that I can remember.
    Mr. Chairman, as you are aware, there is a constant need for 
capital to run our day-to-day operations, build new facilities, and 
develop new technologies. Many companies, even those that are prudently 
managed and producing excellent operational results, are facing severe 
limitations on their ability to access capital.
    This is a serious problem and one that must be addressed today if 
we are to build the 355 gigawatts of new electric capacity the 
Department of Energy states we'll need by 2020. The turbulence in our 
industry already has caused companies to cancel or postpone development 
of approximately 53 gigawatts of new capacity. And while not all of 
these cancellations can be blamed directly on the credit crunch, I am 
very concerned about the impact tomorrow of the financial difficulties 
facing us today.
    I'd like to briefly offer my thoughts on what conditions have 
contributed to today's difficulties, as well as what I view as 
necessary action on the part of industry and government to initiate 
recovery.
    First and most importantly, we need to recognize that today's 
credit crisis is partly the result of a sluggish economy, which has 
reduced the demand for electricity.
    Second, part of our problem is self-inflicted. It would be 
disingenuous not to acknowledge that accounting difficulties, 
accusations of price manipulation, inaccurate financial reporting, and 
fudged and fuzzy balance sheets all have contributed to the lack of 
confidence now being expressed by financial markets and the financial 
community. The actions of a very small minority have affected the 
entire sector.
    Clearly, our industry must take the lead in restoring the 
confidence of investors, regulators, policymakers, and customers in our 
industry and in the value of competition in electricity markets. We are 
moving aggressively to restore confidence on an industry-wide basis by 
implementing the EPSA Code of Ethics and the work of the Committee of 
Chief Risk Officers. On a company-by-company basis, we are shoring up 
our balance sheets, reducing debt levels, and making sure we live by 
the new Sarbanes-Oxley requirements. These efforts are essential and 
will continue.
    The third and final part of the problem involves continued 
uncertainty about the outcome of public policy debate on the future of 
our industry.
    This Committee has asked what Congress can do to help remove 
barriers to the flow of capital. I think there are four areas on which 
Congress can and should focus.
    1. First, Congress can help address regulatory uncertainty by 
enabling FERC to move promptly to establish well-designed regional 
electricity markets across the country. In my view, the minimum 
requirements for a well-designed market include an independent grid 
operator; a real-time spot market with a means for managing congestion; 
a minimum resource adequacy requirement; and a market-monitoring plan 
to ensure all participants obey the rules.
    2. Second, Congress needs to address the current patchwork of state 
and federal environmental regulations for power plant emissions. My 
company has been a strong advocate for national emissions caps with 
market-based compliance mechanisms. This system will provide clear 
direction on environmental policy and a sound basis on which to make 
investment decisions about our facilities. I am pleased this topic is 
on the Congressional agenda, and I encourage Congress to enact multi-
pollutant legislation this year.
    3. The third issue Congress needs to address is reform of the 
bankruptcy code. One of the realities of this credit crunch is that 
some companies will likely face bankruptcy. Our industry has done a 
very good job in mitigating counter-party risk by negotiating netting 
provisions in standard contracts. It is important that Congress pass 
Bankruptcy Reform legislation that ensures these contract netting 
provisions are honored in bankruptcy proceedings.
    4. Finally, I would suggest two changes to the tax code that I 
believe will help spur investment. The first is accelerated 
depreciation of generation assets. Companies that build power plants 
should be provided the same tax treatment as other capital intensive 
industries. As an example, Mr. Chairman, facilities in shipbuilding and 
the pulp and paper industry are depreciable over seven years. The 
chemical and semiconductor industries are on a five-year schedule. 
Electric generation assets, however, are on a 15 to 20 year 
depreciation schedule. This is a disparity that should be corrected.
    And for any publicly-traded company like PSEG that pays dividends, 
elimination of the double tax would be a useful and important 
investment incentive. I realize this is a controversial component of 
the President's economic plan. I hope the debate focuses on the merits 
of the proposal and it goes forward.
    Mr. Chairman, competitive power suppliers are responsible for 80 
percent of all generation capacity added in the past decade. It's very 
important that we address the financial condition of the electricity 
industry now in order to assure our nation continues to be served by 
reliable, affordable, secure and environmentally responsible supplies 
of electric energy.
    Thank you again for the opportunity to appear before the Committee 
this morning. I will be pleased to respond to questions.

    Senator Thomas. Thank you, Mr. Cassidy.
    Ms. Smith.

    STATEMENT OF SUZANNE G. SMITH, DIRECTOR, CORPORATE AND 
             GOVERNMENT RATINGS, STANDARD & POOR'S

    Ms. Smith. Good morning, Mr. Chairman and members of the 
committee. My name is Suzanne Smith. I am a director at 
Standard and Poor's Ratings Services, where I am responsible 
for assessing the credit worthiness of companies in the 
electricity business.
    Standard and Poor's provides independent financial 
information, analytical services, and credit ratings to the 
world's financial markets. We do not advocate any specific 
industry structures or regulatory and energy policies. I 
welcome the opportunity to be here today.
    Since partial deregulation, financial conditions within the 
electricity industry have been unsettled. The industry-wide 
slippage in credit quality that started several years ago is 
still continuing. Last year the decline unexpectedly 
accelerated as electricity prices fell and access to capital 
became constrained.
    Today some companies are trying to return to a regulated 
cost-to-service model by selling unregulated assets. And those 
companies that remain committed to competition are liquidating 
assets to shore up their balance sheets. Many are hunkering 
down for what could be an extended industry slump. All this 
represents a sea change from what had previously been an 
industry of strong, stable, and predictable financial 
performance.
    Ratings for the electric utility industry have historically 
been investment grade, mainly because of the existence of 
regulation. The introduction of competition into the market and 
the increased level of investment in non-energy-related 
businesses, funded with high levels of debt, have caused an 
overall decline in the industry's financial health. Companies 
that are experiencing the most problems are those that have no 
regulated business to temper losses and no financial support 
from a stronger parent.
    In the merchant energy segment, an unprecedented mix of 
financial and business risks have led to financial crisis and 
credit spiraling downward for some companies. Lower power 
prices, trading losses, and excess debt have substantially 
driven down cash flow and profitability.
    Last year, companies engaged in energy marketing and 
trading found themselves without sufficient capital at a time 
when they needed more liquidity to fund losses and to meet 
calls for collateral. Energy marketing and trading is a 
confident, sensitive business. The last of transparency caused 
by energy marketers operating mostly bilaterally and relying on 
their own models to value energy contracts played a role in the 
loss of investor confidence.
    The presence of contingent claims in loan agreements and 
trading contracts made the situation worse by creating a credit 
cliff. Loss of an investment grade rating has required that 
some companies immediately put up hundreds of millions of 
dollars of increased collateral. When lenders or trading 
counterparties are allowed to demand payment or terminate 
credit facilities upon a change to non-investment grade, the 
result can be a crisis that puts the company on the brink of 
default. It is important to note that there are hundreds of 
non-investment grade companies that operate normally with 
stable outlooks, but they do not have ratings triggers. 
Financing practices have also contributed to credit 
deterioration. Many generating companies relied extensively on 
short-term debt to fund construction or acquisition of assets. 
Traditionally, generating assets have been funded through a 
combination of equity and long-term debt. Banks and borrowers 
expected companies to repay the loans through proceeds from 
capital market takeout issues. But today banks realize that the 
capital markets are not a viable source of repayment.
    A small number of energy merchant companies are fighting 
for survival. If these companies cannot refinance the debts 
that became due in 2003, they may have to resort to debt 
restructuring in or out of bankruptcy. But even companies that 
successfully refinance can expect onerous terms and conditions.
    Amidst these problems it is critically important to also 
note that capital is still widely available for this industry. 
For example, in the past 2 weeks, Duke Energy, Virginia 
Electric Power, Southern National Gas, NiSource, American 
Electric Power have all issued bonds. And last week, Allegheny 
Energy and Center Point announced new bank loan deals. Last 
week, Standard and Poor's assigned it's A minus rating to the 
senior secured bank loan of a company called ITC that purchased 
the transmission assets of DTE Energy.
    Even though a large part of the industry continues to 
perform well, it will take time to restore investor confidence. 
The market is capable of working out financial distress, but 
there will be winners and losers. Standard and Poor's has 
previously stated that a competitive wholesale power market 
requires marketing and trading functions. But the industry 
needs to improve these functions through increased transparency 
and disclosure, improve clearing mechanisms, better regulatory 
oversight, and probably the entry of some financial partners.
    It is becoming increasingly clear that energy trading 
cannot function without a high investment grade rating. Most 
investors also agree that resolution of pending investigations 
would help investor confidence.
    More certainty in the regulation and market structure would 
also improve investor confidence. Investors have long looked to 
the regulator safety net to provide stability to the industry. 
Standard and Poor's views regulation as generally being very 
supportive of credit quality, but does not see a trend of 
strong intervention by regulations to promote the financial 
health of utilities.
    Lastly, partial deregulation has contributed to the 
financial deterioration of electricity markets by creating 
competition in the wholesale markets without corresponding 
competition in the retail markets, by not providing adequate 
incentives for investment and transmission, and by not 
providing clear market rules.
    In offering these comments, I reiterate that Standard and 
Poor's does not advocate specific market structures or 
policies. But as industry analysts, we are available to comment 
and offer opinions on whether we see policies as supportive of 
or detrimental to credit quality and financial health. And, 
therefore, I appreciate very much the opportunity to offer our 
perspective in this hearing.
    Thank you.
    [The prepared statement of Ms. Smith follows:]

    Prepared Statement of Suzanne G. Smith, Director, Corporate and 
                 Government Ratings, Standard & Poor's

    Good morning, Mr. Chairman and members of the Committee. My name is 
Suzanne Smith. I am a director in the Corporate & Government Ratings 
group at Standard & Poor's Ratings Services. I am responsible for 
assessing the creditworthiness of regulated utilities, diversified 
energy companies and energy merchants. Standard & Poor's, a division of 
The McGraw-Hill Companies, provides independent financial information, 
analytical services and credit ratings to the world's financial 
markets. Standard & Poor's does not advocate any specific industry 
structures or regulatory and energy policies. Standard & Poor's 
welcomes the opportunity to be here today to discuss current financial 
conditions facing the electricity sector.

                              INTRODUCTION

    Over the past two years, there has been heightened attention paid 
to the financial condition of the electricity industry. There are a 
number of reasons for this. Following partial deregulation of the 
industry, the electricity sector that has resulted is marked by a 
greater degree of disparity in its financial health. An industry-wide 
slippage in credit quality that started several years ago (before the 
advent of deregulation) is still continuing. Last year there was an 
unexpected acceleration of the slippage as electricity prices fell and 
access to capital became constrained. Today, credit concerns dominate 
the industry's strategic decision-making and the management of its 
trading and marketing risk. For some participants, a return to a 
regulated, ``cost-of-service'' model is being pursued as a way to 
preserve financial health, while others, who remain committed to 
competition, are liquidating assets to shore up their balance sheets 
and are hunkering down for what could be an extended industry slump. 
Some so-called ``merchant energy'' and ``diversified energy'' companies 
are struggling for their very survival, while a handful of less-
affected companies are pursuing opportunistic asset purchases and 
investments in the sector. All this represents a sea change from what 
had previously been an industry of strong, stable and predictable 
financial performance.
    Historically, ratings for the electric utility industry have been 
investment grade (the top four categories of the rating scale, from 
``AAA'' to ``BBB'') mainly because they were regulated. In addition to 
their regulated activities, some utilities have ``unregulated'' 
operations. In this competitive side of the industry, where there is no 
regulatory safety net, the restoration of investor confidence will 
require market participants to work out their current financial 
problems. It will also require participants to overhaul their trading 
and marketing models, to promote more and better transparency in their 
market rules and practices and provide for increased transmission 
access and investments.

                   RATINGS DISTRIBUTION AND OUTLOOKS

    Over the last three years, the overall credit quality of the 
electricity industry has declined. Today only 2% of U.S. electric and 
gas companies are rated by Standard & Poor's in the `AA' category. Two 
years ago the percentage of AA-rated companies was nearly 7%. 
Similarly, 18% of companies now carry ratings that are below the 
investment grade cut-off of `BBB-'. Two years ago, the percentage below 
investment grade was only 6%. The average rating for the industry, 
while still investment grade, has slipped from `A-' to `BBB+' and is 
likely to fall to `BBB'.
    The introduction of competition into the electricity market and the 
increased level of investment in other non-energy related businesses, 
which were funded with high levels of debt, have caused an overall 
decline in the industry's financial health. What has most shocked the 
business and financial community, however, is the speed at which some 
of the largest players in the industry deteriorated in 2002, and the 
realization that the road to financial health is a bumpy one.
    Since the advent of deregulation, the industry has generally moved 
from vertically integrated utilities to a mix of disaggregated 
electrical generation companies (gencos), distribution companies 
(discos), transmission companies (transcos) as well as integrated 
companies. They are not uniform in their financial health. For the 
regulated discos and gencos, the overall financial condition has 
generally remained stable. In fact, a small number of discos and 
transcos actually experienced financial improvement last year. Public 
power and municipality-owned utilities have also generally fared well. 
Standard & Poor's has observed that electric utility holding companies, 
especially those with unregulated generation or energy trading and 
marketing operations, witnessed a sustained decline in creditworthiness 
in 2002 that began at least three years ago. The companies that 
experienced the most dramatic and negative change in financial health 
are those that are operating in competitive power markets; companies 
that have no regulated business to temper losses and no financial 
support from a stronger parent.

                           ACCESS TO CAPITAL

    Many companies operating in competitive power markets have 
experienced a severe reduction in capital availability from the debt 
and equity markets, and high hurdles in accessing the syndicated bank 
loan market. There is no single reason to explain why access to capital 
has become constrained. Rather, there has been an unprecedented 
collision of negative business and financial factors that have caused a 
downward credit spiral and financial crisis for some companies.
    Low power prices, trading losses and excess leverage have 
substantially driven down cash flow and profitability for the merchant 
energy (the uncontracted-for) segment of the electricity business. 
Merchant gencos generally earn only marginal revenues and are 
characterized by a limited ability to cover their fixed costs. The 
weakened economy and incomplete or partial deregulation may also be 
contributing factors to a reduction in capital availability, but they 
are not as much of a driver as is the overall surplus of electric 
generation capacity that now exists in most regions of the United 
States. This surplus is expected to remain for the next several years.
    Last year, companies engaged in energy marketing and trading found 
themselves without sufficient capital at a time when they needed more 
liquidity to fund losses and to meet collateral calls. These 
developments occurred during a period of increasing regulatory 
uncertainty and investigations, and amid a perception throughout the 
United States of failures in corporate governance. Energy marketing and 
trading is a confidence-sensitive business. The lack of transparency 
caused by energy marketers operating mostly bilaterally (one-on-one 
with counterparties) and relying on their own models to value energy 
contracts may well have contributed to the loss of investor confidence. 
This lack of transparency may also have contributed to investor 
distrust about the adequacy of disclosure and it made more obvious 
company's abilities to manage earnings and valuations. Loss of investor 
confidence caused industry stock prices to plummet and virtually shut 
many energy companies out of the equity markets.
    The presence of contingent liabilities in loan agreements and 
trading contracts made the situation worse by creating ``credit 
cliffs''. Contingent liabilities exist where the terms of borrowing 
change (or repayment is accelerated) if debt ratings or financial 
performance, or both, deteriorate below specified levels. In the 
electricity markets, ``ratings triggers'' are used extensively by 
counterparties as a way to determine collateral requirements. A common 
trigger is the loss of an investment grade rating, which required some 
companies to immediately post hundreds of millions of dollars of 
increased collateral. Thus, where an energy trading company contracts 
to provide power to a utility counterparty at a specified time in the 
future, the contract will provide that if the trading company falls 
below investment grade (and thus may be unable to procure the power for 
the utility) that the counterparty post sufficient collateral to allow 
the utility to shop elsewhere for its needs. If the trading company has 
triggers in a material number of its contracts, its capital can be 
quickly depleted. There are hundreds of non-investment grade companies 
that operate normally and finance normally--and, certainly, the 
majority of them are not expected to default. Yet, if, lenders or 
trading counterparties demand collateral or even the right to terminate 
credit facilities upon a change to non-investment grade, the result can 
be a crisis that puts the company on the brink of default. This is 
known as a ``credit cliff.''
    Another contributing factor to credit deterioration is financing 
practice. Many gencos relied very heavily on the near-term debt 
markets, chiefly through the medium of short- and medium-term 
construction revolvers, acquisition bridge loans, and ``mini-perm'' 
loans to fund construction or acquisition of individual merchant energy 
plants and portfolios of merchant assets. This departs from the 
traditional way in which generating assets are traditionally funded, 
that is with more reliance on equity and long-term debt. Banks and 
borrowers as near-term lenders expected that their loans would be 
repaid within two to five years, mainly from proceeds from capital 
market ``take-out'' issues. Standard & Poor's estimates the refinancing 
requirement to be $90 billion over the next four years, with about $40 
billion coming due in 2003. Today, because of the uncertainties in the 
electricity sector, the capital markets are unwilling to invest in 
generating facilities and capital markets are not a viable source of 
repayment for the banks. Making matters worse, some banks want to 
reduce their exposure to the electricity sector and are reluctant to 
roll over or refinance outstanding loans. Some companies are deeply 
exposed as the vast majority of their capitalization consists of short- 
or medium-term bank loans that mature this year or next.
    Amid these problems, it is important to note that capital is still 
available for many segments of the electricity industry, especially for 
the regulated side and for unregulated gencos having long-term 
contracts with creditworthy counterparties. Standard & Poor's utility, 
energy and project finance group is still frequently asked to assign 
ratings to new capital-markets debt issues and bank loan facilities. 
Examples of the past two weeks' activity includes ratings for Duke 
Energy Corp.'s $500 million of mortgage bonds, Virginia Electric 
Power's $400 million notes, Southern Natural Gas' $400 million notes, 
and NiSource's $345 million of senior notes. Last week, new bank loan 
ratings were announced for American Electric Power, Allegheny Energy 
and Centerpoint. On February 26, Standard & Poor's assigned its A- 
rating to the senior secured bank loan of a transmission company called 
ITC that purchased the transmission assets of DTE Energy. Looking 
further back, bond issuance in the fourth quarter of 2002 totaled $17 
billion. While this amount represented a decline of 24% from two years 
ago, when bond issuance was $22 billion, recent activity demonstrates 
that access to capital markets has not been denied to the sector as a 
whole.

                          STRATEGIC RESPONSES

    Recently, poor industry fundamentals along with limited access to 
capital have caused industry participants to focus on creditworthiness 
more than in previous years. Credit issues now influence corporate 
strategies in ways that were not previously considered. Companies with 
relatively strong credit ratings that were previously willing to make 
aggressive moves in the market may now be unwilling to consider 
acquisitions because they do not want to jeopardize their access to the 
capital markets. However, there appear to be other companies and new 
entrants with cash that are interested in obtaining distressed utility 
assets.
    Increasingly, strategies in the electricity sector are focusing on 
debt reduction, balance sheet improvement and scaling back on marketing 
and trading and merchant power generation. For most companies, the way 
to financial health rests, not surprisingly, through debt reduction by 
generating positive cash flow after paying capital expenditures, 
interest, and dividends. A common strategy features a return to the 
practice of increasing assets in the rate-base and collecting a 
regulated cost-of-service return. Some companies have obtained 
regulatory orders that transfer previously unregulated merchant plants 
into regulated rate-based assets. Companies with merchant asset 
portfolios are dealing with the spectre of a prolonged slump by 
canceling or renegotiating turbine contracts, canceling projects under 
development as well as partially completed plants, and, in a handful of 
cases, abandonment of nearly completed projects. Many companies 
announced that they were exiting or severely curtailing their marketing 
and trading operations. And regardless of whether the company is 
pursuing improved cash flow through operations, regulatory relief, or 
termination or abandonment, it is also likely to pursue asset sales.
    Though Standard & Poor's views most of these strategies as prudent 
for maintaining or improving companies' financial health, they are not 
the only way the industry may recover. If successfully implemented, 
creditworthiness should strengthen. A few companies continue to expand 
through acquisitions without a loss in their credit rating.
    There are risks, however. Executing asset sales can be problematic 
and expensive. Assets sales are problematic because of the timing and 
price of the sale, as well as the loss of cash flow that occurs once 
the asset is sold. Although gas pipelines and power plants with long-
term contracts are selling briskly, merchant power plants are not. 
Sales of international investments are showing mixed results, with many 
(Latin American assets, for example) selling at a loss. Additionally, 
in some cases these strategies will take several years to implement 
before material debt reduction will be realized, especially if the 
profitability of merchant plants remains low.
    One obstacle that is confronted in any sale of a merchant power 
facility is establishing its value. In general, valuations are lower 
than was initially anticipated--but by how much? At present, there is 
no clear answer. Standard & Poor's anticipates that market comparables 
will emerge over the next year as distressed borrowers and their 
lenders face decisions on how to handle merchant energy debt. Merchant 
plant valuations will need to be established and they will set the 
stage for restructuring and consolidation.
    Standard & Poor's, along with the rest of the industry, observes 
that a small number of energy merchant gencos are literally fighting 
for survival due to a lack of market liquidity. Their future rests on 
the ability to refinance debt and, as such, their fate depends on the 
decisions of bank loan arrangers and syndicates. If these companies 
cannot refinance the loans coming due in 2003, they may resort to debt 
restructuring, either in or out of bankruptcy. Gencos or other 
distressed energy companies that refinance successfully can still 
expect onerous terms and conditions, including removal of the ability 
to ``term out'' (refinance through a long-term loan facility) one-year 
revolving loans, more stringent financial covenants, and commitments to 
reduce bank loans over time through asset sales or capital market 
issues. Pledges of collateral security are expected to continue. Higher 
fees and credit spreads are also to be expected. Again, however, there 
are bright spots in the survival camp. In December 2002, AES Corp. 
completed a major refinancing which extends by a few years many of the 
company's debt maturities. Under current conditions, the market has 
viewed AES's refinancing as achievement.

                     RESTORING INVESTOR CONFIDENCE

    Standard & Poor's believes that investor confidence in the industry 
may take time to restore, even though a portion of the industry 
continues to perform well. Companies have already taken steps to 
restore investor confidence by revising business strategies, improving 
financial and risk disclosure, making provision for liquidity, and 
removing ratings triggers. Confidence should improve when near-term 
refinancings are worked out, when the handful of companies that may go 
bankrupt do so, when revised strategies prove successful or otherwise 
meet their fates, and when banks and borrowers complete the write-offs 
of their losses. All of this will take time--at least the next 18 
months, and probably considerably longer. The market is capable of 
working out financial distress, but there will certainly be winners and 
losers.
    In several of its publications, Standard & Poor's has stated that a 
functioning competitive wholesale energy market requires competent 
marketing and trading functions. These functions include robust, deep 
and liquid markets offering a range of products and tenors. A 
competitive wholesale energy market has proven difficult to establish. 
Nevertheless, Standard & Poor's has not moved from its original 
position. The restoration of investor confidence depends on effectively 
overhauling the existing model for trading electricity. It is currently 
unclear how the overhauling process will work out and what, exactly, 
will emerge. What is clear, however, is that trading operations, 
similar to financial institutions that conduct derivative trading 
businesses, require high investment-grade ratings. As noted previously, 
this is due to the requirement that energy marketers meet and pay short 
term trading losses without suffering material loss of liquidity. 
Trading operations at the low end of the investment grade scale (BBB-
range) or at less than investment grade (BB and lower) are not viable 
because the dramatically higher capital requirements are an inefficient 
use of capital. This fact explains why so many companies have announced 
they are either exiting the business or are looking for partners. The 
volatility of earnings from trading and marketing make it a business 
that cannot sustain high levels of debt.
    Restoring investor confidence also relies upon improving investors' 
understanding of how risk and credit exposure are measured. Standard & 
Poor's believes that a successful overhaul of the trading and marketing 
model will require increased transparency and disclosure, probably the 
entry of financial partners, improved clearing mechanisms, and better 
regulatory oversight. Most investors agree that resolution of pending 
investigations would certainly help investor confidence.
    Finally, a measure of certainty regarding regulation and market 
structure might also improve investor confidence. Investors have long 
looked to the regulatory ``safety net'' to provide stability to the 
electricity industry. Ratings for the electric utility industry have 
historically been investment grade mainly because regulation 
traditionally allowed utilities to earn steady and predictable returns 
over sustained periods. As a result investment grade rated utilities 
have generally been able to enjoy lower cash flow ratios than their 
comparably rated industrial peers. Notwithstanding any other benefits 
wrought by deregulation, Standard & Poor's views traditional regulation 
as generally supportive of credit quality. In recent years, however, it 
does not appear that there has been a trend of strong intervention by 
regulators to promote the financial health of utilities. A Standard & 
Poor's survey of state regulatory commissioners conducted in 2001 
indicated that credit quality ranked low on their list of priorities. 
Areas of concern include the apparent lack of attention that regulators 
appear to give to utilities' nonregulated investments, and the threat 
to utility credit quality from their parents' activities and uncertain 
rulings. Recent regulatory action to protect credit quality by 
isolating the utility from the activities of its parent or affiliates, 
such as the example of Westar Energy and Kansas Gas & Electric Co. 
appear to be a departure from the existing trend, but Standard & Poor's 
notes that the company first had to reach a crisis before regulators 
acted.
    Partial deregulation has contributed to the financial deterioration 
of the electricity markets in at least three ways. First, the example 
of California indicates the problems of creating competition in the 
wholesale supply business without comparable competition in the retail 
side of the business. This mismatch has the effect of shifting business 
and financial risk from customers to shareholders and lenders. Second, 
unregulated gencos have encountered difficulty competing against 
regulated cost-of-service generation where regulated utilities are able 
to pass on to customers the fixed costs of generation. The competitive 
market, however, is not currently compensating merchant power producers 
for their fixed capital investments. Lastly, transmission congestion is 
still managed physically. Standard & Poor's believes that economic 
incentives to invest in new transmission facilities are inadequate. 
FERC's recent ruling to boost returns on transmission investments 
appears to create a positive economic incentive for increasing the 
transmission infrastructure.

                               CONCLUSION

    In offering these comments, I would reiterate to the Honorable 
Members that Standard & Poor's does not advocate market structures, 
practices or regulatory policies. As analysts, we comment and offer 
opinions upon those structures, practices and policies as supportive of 
or detrimental to credit quality and financial health.
    This concludes my testimony on behalf of Standard & Poor's Ratings 
Services. I will be happy to answer any questions.

    Senator Thomas. Thank you very much.
    Mr. Sokol.

  STATEMENT OF DAVID L. SOKOL, CHAIRMAN AND CEO, MIDAMERICAN 
                    ENERGY HOLDINGS COMPANY

    Mr. Sokol. Thank you, Mr. Chairman and members of the 
committee. My name is David Sokol, chairman and CEO of 
MidAmerican Energy Holdings Company, a diversified energy 
company headquartered in Des Moines, Iowa, with approximately 
$18 billion in assets and operating in 22 of the United States.
    This hearing goes to the heart of the most important energy 
issue facing Congress today, the financial crisis in the 
electricity and natural gas sectors. This sector is facing its 
greatest crisis in over 70 years as capital flees this industry 
at an alarming rate.
    Among the 25 largest utilities alone, more than $100 
billion in market capitalization has been lost in the last 2 
years. We have seen a net flow of capital out of utility funds 
in 48 of the last 60 months. The uninterrupted outflow over the 
last 2 years runs directly contrary to this sector's normal 
position as a safe haven in difficult economic times.
    Indeed, 10 years ago, individual investors owned nearly 60 
percent of U.S. utility stocks. But because of instability and 
dividend cuts, that percentage is now one half what it used to 
be. In the last 5 years, utility debt ratios have climbed from 
54 to 63 percent, raising interest rates across the sector and 
causing new infrastructure to be built, if at all, with riskier 
and more expensive debt.
    As interest rates have fallen 200 basis points across the 
board in the last 2 years, utilities costs of funds have 
actually risen by as much as 400 basis points over the overall 
credit index, whereas historically utilities borrowed money at 
a lower cost than other industries.
    Between Moody's and Standard and Poor's in the last year 
they gave the energy sector 203 credit downgrades and only 6 
upgrades, which is more downgrades than the total number of 
downgrades for the----
    Senator Thomas. I do not think your microphone is on. Mr. 
Sokol. Sorry.
    Senator Thomas. Could you push your button?
    Mr. Sokol. You bet.
    Senator Thomas. Thank you.
    Mr. Sokol [continuing]. Previous 9 years. Twenty years ago, 
more than two-thirds of utilities held A or better credit 
ratings. Today that fraction is one-third. Now what does all 
this mean? It means that the capital markets no longer see 
electricity in the natural gas sector as a safe haven. And 
worse, barriers to investment are preventing willing companies, 
both in and outside of the industry from stepping forward with 
equity investments.
    Experts estimate that up to $100 billion in equity capital 
is available for this industry, but it sits on the sidelines 
today because of regulatory impediments. Indeed, this $100 
billion in capital would translate into hundreds of thousands 
of new jobs in this sector, if it were invested. Our largest 
investor, Berkshire Hathaway, one of the only AAA-rated 
companies in the United States, has publicly stated its desire 
to invest an additional $10 billion to $15 billion in the 
utility sector, if barriers to investment caused by the Public 
Utility Holding Company Act were lifted.
    The real world impacts of these negative trends are far 
reaching. Utility dividends have fallen by more than 20 percent 
in the last 3 years. Combined with market losses, the effect on 
utility investors has been devastating. In the last 3 years, 
more than 170,000 megawatts of planned new capacity have been 
tabled or canceled. Some of these cancellations represented 
appropriate correction for the over building that was taking 
place, but many needed projects are also being suspended.
    Moreover, there is significant under-investment in the 
transmission facilities also caused by this lack of capital 
availability. And it is not likely to be improved soon, 
notwithstanding the greatly increased need for redundancy 
because of homeland security concerns.
    New projects and cancellations make headlines. But rarely 
do investors put up a red flag saying: I am not investing. But 
that is what is happening today. Ironically, this crisis has 
benefitted our company because much of the banking community 
has written off the electricity sector as a home to too much 
bad debt. As a result, Berkshire Hathaway and MidAmerican have 
become lenders of last resort in the industry, propping up 
companies through loans and with acquisitions.
    We cannot make major equity investments in the electricity 
sector, however. But we have made loans to utilities where no 
other lender could be found. These loans represent good short-
term opportunities for us. But this is not the way the industry 
should be capitalized in the long term.
    What then must Congress do? For several years I have 
testified before Congress calling for comprehensive national 
energy legislation. We almost achieved that goal last year. But 
we came up short. But instead of finger pointing, let us look 
at the lessons we learned last year, which is that Congress 
cannot wait to act until political consensus is reached on 
every issue. That merely works to the advantage of those who 
take extremely positions in the policy arena or who prosper as 
a result of market failures.
    This is no longer an exercise in academic policy making, 
but rather a critical component of any economic recovery 
program. Getting capital flowing back into this industry will 
have a direct impact on employment economic development and the 
quality of life for millions of Americans, particularly 
including senior citizens who depend on utility dividends and 
reasonable energy prices.
    Congress cannot and should not spend billions of dollars 
trying to fix this problem, however. But it can pass 
legislation to permit the private sector to make long-term 
investments in the industry.
    How? First, repeal PUHCA to allow for intelligent 
investment. Healthy players must be allowed to invest in 
utility assets to stabilize the industry.
    Let me give you two first-hand examples. Last spring we 
purchased the Kern River natural gas pipeline from the Williams 
Company, which had planned to double the size of this critical 
piece of Western energy infrastructure to deliver more natural 
gas from the great State of Wyoming to Nevada and California. 
Williams, facing severe financial distress, could not have 
undertaken this $1.2 billion expansion. We did. And the project 
will come on line May 1 of this year.
    The Kern River employees, communities, and consumers in 
four Western States will all benefit. This expansion will bring 
nearly a billion cubic feet per day of additional natural gas 
to customers in Utah, Nevada, and California, who have already 
contracted for this capacity for 15 years. If we had not 
committed to buy Kern River, this expansion would not have 
occurred. But if Kern River were a wire, instead of a pipe, 
MidAmerican could not own it, because of PUHCA.
    Another example, last summer we purchased the Norther 
Natural Gas pipeline system from Dynegy, who had just purchased 
it from Enron. This former Enron subsidiary is now on sound 
financial footing. And its employees once again have job 
security. In contrast, Enron's Portland General Electric 
facility remains subject to bankruptcy proceedings. And no 
qualified buyer has stepped forward to PGE. Enron, Portland 
General, and even their bankruptcy consultants have all come to 
us, encouraging us to bid on Portland General. But because of 
PUHCA, we cannot.
    Secondly, we must make modest changes to the tax code to 
encourage the structural separation of transmission and 
generation assets and to encourage new investment in 
infrastructure and renewable energy.
    Third, enact bankruptcy reform to help reduce counterparty 
risks associated with the energy markets. And fourth, 
streamline the siting of transmission infrastructure to 
facilitate new investment and reliability.
    Congress's first goal this year must be to promote utility 
investment. You may not be able to resolve every policy issue 
facing the energy industry today, but the items outlined above 
must be addressed to help get this industry and our economy 
moving again.
    Thank you.
    [The prepared statement of Mr. Sokol follows:]

  Prepared Statement of David L. Sokol, Chairman and CEO, MidAmerican 
                        Energy Holdings Company

    Mr. Chairman and members of the Committee, my name is David L. 
Sokol, Chairman and CEO of MidAmerican Energy Holdings Company, a 
diversified international energy company headquartered in Des Moines, 
Iowa with approximately $18 billion in assets.
    MidAmerican Energy consists of six major subsidiaries: CE 
Generation (CalEnergy), a global energy company that specializes in 
renewable energy development in California, New York, Texas and the 
West, as well as the Philippines; MidAmerican Energy Company, an 
electric and gas utility serving the states of Iowa, Illinois and South 
Dakota; Northern Electric/Yorkshire Electricity, an electric and gas 
utility in the United Kingdom; the Kern River Gas Transmission Company, 
operating in Wyoming, Utah, Nevada and California; Northern Natural 
Gas, the largest gas transmission system in the country, running from 
the Permian Basin in Texas and New Mexico through Oklahoma and Kansas, 
and into the entire Upper Midwest; and HomeServices of America, the 
second-largest residential real estate company in the country, 
operating in 14 states.
    I believe that MidAmerican provides a clear example that an energy 
company can be large, but still maintain a singular focus on the 
customer; diversified in scope and operations, yet concentrated on 
business fundamentals; growth-oriented, while resistant to the fad of 
the moment.
    Mr. Chairman, this hearing goes to the heart of the most important 
energy issue facing Congress--the financial crisis in the electricity 
and natural gas industries. This sector is facing its greatest crisis 
in 70 years as capital flees the industry at an alarming rate. Among 
the 25 largest utilities alone, more than $100 billion of market 
capitalization has been lost since 2000.
    We have seen a net flow of capital out of utility funds in 48 of 
the last 60 months and in the few months that saw positive flows, most 
were negligible. Most disturbingly, the uninterrupted outflow over the 
last two years runs directly contrary to the sector's normal position 
as a safe haven in difficult economic times. Indeed, ten years ago 
individual investors owned nearly 60% of utilities' stock. Because of 
instability and dividend cuts, that percentage has been cut in half 
today. The mom and pop investors, ``the widows and orphans'' who 
financed so much of this industries' growth for decades, are fleeing 
the sector as the risk profile of the industry has increased 
dramatically. Even companies that do not have substantial exposure in 
areas such as trading and merchant generation have suffered because of 
negative perceptions of the industry in general.
    What, then, has taken the place of the individual investor? 
Unfortunately, in many cases, the answer is debt. In the last five 
years, utility debt ratios have climbed from 54 to 63 percent, raising 
interest rates across the sector and causing new infrastructure to be 
built, if at all, with riskier and more expensive debt.
    As interest rates have fallen 200 basis points in the last two 
years, utilities' cost of funds has risen as much as 400 basis points 
above the overall credit index--whereas historically utilities borrowed 
at rates below other industries. When you consider that the electric 
and gas industries are the most capital-intensive sectors of the entire 
economy, the negative impact of this trend is magnified even further.
    Moody's and S&P gave the power sector 203 credit downgrades last 
year and only 6 upgrades. This is more downgrades than the total number 
of downgrades for the previous nine years. In the two previous years, 
downgrades outnumbered upgrades by almost 2-1 and more than 5-1, 
respectively.
    Twenty years ago, more than two-thirds of utilities held ``A'' or 
better credit ratings. Today, that fraction is one-third. Some 
retrenchment in the sector was inevitable, as too many companies 
followed a ``build it and they will come'' model that ignored the 
natural limitations on sector growth that characterize the industry. 
Hopefully, the days when energy companies were pressured from all sides 
to ``be more like Enron'' are gone and won't soon be forgotten. 
However, as long as the sector remains subject to competition and 
uncertainty and access to capital remains restricted, we do not see 
this negative trend reversing.
    What does all this mean? The capital markets see the electricity 
sector as high risk. And worse, barriers to investment are preventing 
willing companies, both in and outside of the industry, from stepping 
forward with equity investments. In this riskier, highly competitive 
environment, willing investors must step forward with long-term equity 
that can ride out the inevitable fluctuations in the business cycle. 
Unfortunately, federal law continues to restrict this.
    Experts estimate that up to $100 billion in equity capital 
available for the industry sits on the sidelines today because of 
regulatory impediments. Indeed, this $100 billion in capital would 
translate into hundreds of thousands of new jobs in this and related 
industries. Our largest investor, Berkshire Hathaway, one of the only 
AAA-rated companies in the United States, has publicly stated its 
desire to invest $10 to $15 billion in the utility industry if the 
barriers to investment caused by the Public Utility Holding Company 
Act--PUHCA--are lifted.
    Healthy players must be allowed to invest in utility assets to 
stabilize the industry.
    The real world impacts of these negative trends are far-reaching.
    Utility dividends have fallen by more than 20% percent in the last 
three years. Combined with market losses, the effect on utility stocks 
has been devastating.
    In the last three years, more than 170,000 megawatts of planned new 
capacity have been tabled or canceled. Some of these cancellations 
represent an appropriate correction for overbuilding, but some needed 
projects are also being suspended. Moreover, there is significant 
under-investment in transmission facilities, also caused by the lack of 
capital availability, and it is not likely to be improved soon, 
notwithstanding the greatly increased need for redundancy because of 
homeland security concerns. New projects and cancellations make 
headlines, but rarely do investors put up a red flag to say: ``I'm not 
investing.'' But that is what's happening today.
    If we fail to turn this situation around, I fear we will be laying 
the groundwork for a repeat of the Western energy crisis. For the many 
Senators on this Committee from the West, I hope you will ask 
yourselves why an Enron was able to manipulate markets in your region, 
but not the markets of other regions. The answer, I believe, is that 
the West was dangerously short of both capacity and the infrastructure 
to deliver that supply to market. Coupled with the terribly conceived 
California market structure, conditions were ripe for anti-consumer 
behavior. Adequate supply and sensible market rules have delivered 
billions of dollars of savings to consumers in markets such as the 
Northeast, Midwest and Texas, with no evidence of significant anti-
consumer behavior.
    Ironically, the capital crisis has benefited our company, because 
much of the banking community has written off the electricity sector as 
home to too much bad debt. As a result, Berkshire and MidAmerican have 
become lenders of last resort in the industry, propping up companies 
through loans and acquisitions. We cannot make major equity investments 
in the electric sector, but we have made loans where no other lender 
could be found. These loans represent good short-term opportunities for 
us, but this is not the way the industry should be capitalized in the 
long term.
    What, then, must Congress do?
    For several years, I have testified before Congress calling for 
comprehensive national energy legislation. We almost achieved that goal 
last year, but came up short. Instead of finger pointing, let's look at 
the lesson learned from last year: Congress cannot wait to act until 
political consensus is reached on every issue. That merely works to the 
advantage of those who take extreme positions in the policy arena or 
who prosper as a result of market failures.
    This is no longer an exercise in academic policy making, but rather 
a critical component of any economic recovery program. Getting capital 
flowing back into this industry will have a direct impact on 
employment, economic development, and the quality of life for millions 
of Americans, particularly senior citizens who depend on reasonably 
priced energy and utility dividends.
    Congress cannot, and should not, spend billions of dollars trying 
to fix this problem, but it can pass legislation to permit the private 
sector to make long-term investments in this industry.
    How? First, repeal PUHCA to allow for intelligent investment. Let 
me give you two first-hand examples of why you should: Last spring, we 
purchased the Kern River natural gas pipeline from the Williams 
Company, which had planned to double the size of this critical piece of 
Western energy infrastructure to deliver more natural gas from Wyoming 
to power-hungry Nevada and California. Williams, facing severe 
financial distress, could not have undertaken this $1.2 billion 
expansion. We did, and the project will be completed on time this May.
    The Kern River employees, communities and consumers in four Western 
states will all benefit. This expansion will bring an additional 900 
million cubic feet per day of natural gas to customers in Utah, Nevada 
and California, who have fully contracted for that capacity for 15 
years. If we hadn't come in to buy Kern River, this expansion would not 
have occurred. But if Kern River were a wire, not a pipe, MidAmerican 
could not own it--because of PUHCA.
    Another example: Last summer we purchased the Northern Natural Gas 
pipeline system from Dynegy. This former Enron subsidiary is now on 
sound financial footing and its employees once again have job security. 
In contrast, Enron's Portland General electric utility remains subject 
to bankruptcy proceedings, and no qualified buyer has stepped forward 
to own PGE. Enron, PGE, even the bankruptcy court, have all encouraged 
MidAmerican to bid on PGE. Under PUHCA, we can't.
    Leaving aside for a moment the fact that Enron caused its own 
problems with its irresponsible and, at times, outright illegal 
behavior, there is a larger systemic issue here. One of the biggest 
problems in the market is that when Congress chose in 1992 to expose 
electric utilities to competition, it provided no means for assets to 
be reallocated when a company does poorly in the competitive 
environment.
    Federal and state regulators have expansive authority to ring fence 
regulated utility assets to insulate them from bad investment outcomes 
from parent companies or competitive affiliates. Long-term, however, 
you don't want a utility operating under a parent that cannot maintain 
healthy finances. You can't just leave the walking wounded out there, 
but that's what current law does. Once PUHCA is repealed, it is 
important to note that utility mergers and major transactions will 
still be subject to FERC, state regulatory and DOJ or FTC approval to 
ensure they are consistent with the public interest.
    Second, make modest changes to the tax code to encourage the 
structural separation of transmission and generation assets and 
encourage new investment in infrastructure.
    The provisions on separating transmission from generation enjoy 
broad support from industry stakeholders as necessary to facilitate the 
formation of RTOs. FERC Chairman Pat Wood has testified on a number of 
occasions that this is one of his highest priorities in any energy bill 
that Congress considers. While this provision carries a budget scoring 
``cost,'' there is no real world cost to making this change in the tax 
code.
    Companies simply will not take a 30 percent tax hit on selling 
their transmission assets, so there is no real revenue to be lost by 
making this change. The main issue is whether companies are forced to 
structure sub-optimal transactions to avoid a taxable event or whether 
the law can be changed to accommodate a straightforward spin-off.
    Another element of the tax package should include incentives for 
socially beneficial energy infrastructure investments. Among the 
provisions that should be considered are expanding the production tax 
credit to all renewable resources, accelerating depreciation for 
investments in new transmission and new transmission technologies, and 
accelerating depreciation for new investments in pollution control, 
repowerings, and high-efficiency technologies.
    Last year, the Senate passed a bipartisan package of tax provisions 
related to the electric and gas industries that enjoyed broad support. 
These provisions were not highly controversial and would have 
encouraged new investment in electric transmission and renewable 
energy. Like PUHCA, these tax issues have been around for years, enjoy 
broad support, and would send a clear positive message to Wall Street.
    Also, while the President's proposal on eliminating the double 
taxation of dividends is more of a macro issue and would not have a 
major direct impact on MidAmerican because we are a privately-held 
company, the overwhelming majority of electric and gas companies are 
dividend payers, and enacting the President's proposal would broadly 
benefit the industry.
    Third, enact bankruptcy reform to help reduce counter-party risk 
associated with energy markets. I believe the days of expecting energy 
trading to be a huge profit center for a large number of companies are 
probably over. At MidAmerican, we have always thought of trading as a 
way to hedge risk, not as the means to generate asset-free profits.
    However, there is a critical role for energy trading in the 
marketplace as a whole. Efficient wholesale energy markets depend on a 
liquid trading sector to help match buyers and sellers. While I 
understand that bankruptcy reform has been derailed over somewhat 
extraneous issues in recent years, the element that is important to the 
energy industry is allowing for ``cross-product netting.'' This 
provides counter-parties with the assurance that all transactions 
between two parties can be safely enforced under a Master Netting 
Agreement.
    In the earliest stages of the Enron meltdown, I ordered all of our 
business units at MidAmerican to review their levels of counter-party 
risk and take immediate actions to avoid exposure to potentially 
insolvent parties. For individual companies, that's a prudent course of 
action. The downside of hundreds of companies each moving to reduce 
counter-party exposure is that, in the aggregate, transaction costs are 
increased and markets become less liquid. Clarifying these provisions 
is a cost-free action that Congress can take to get energy markets 
moving in the right direction again.
    Fourth, streamline the siting of transmission infrastructure to 
facilitate new investment and enhance reliability.
    For several years, proposals to give FERC greater authority over 
the siting of interstate transmission lines have languished in 
Congress. It may well be the case that, at this time, this is simply a 
bridge too far. Anything you can do here would be a step in the right 
direction. Demands on the transmission system continue to soar while 
investment levels are flat or declining. A major cause of this is Wall 
Street's fear that a major interstate transmission project can be a 
black hole of company time, money and focus. There are important steps 
that Congress can take that are less controversial than interstate 
siting authority, such as requiring the establishment of joint federal-
state siting boards and streamlining federal agency processes for 
siting transmission across federal lands.
    Finally, I have serious reservations about legislating on FERC's 
Standard Market Design proposal. SMD is neither the regulatory 
Frankenstein nor a laissez-faire Dracula that opponents have painted. 
Reasonable people can differ over exactly what market design rules 
should be, but attempting to legislate them will most likely increase 
uncertainty in the markets.
    Policymakers need to study successfully working electricity markets 
to determine how best to avoid the next California crisis. As I 
discussed earlier, a significant factor is creating incentives for new 
investment and infrastructure. A second element is applying lessons 
learned in well-functioning markets to those that have evident 
structural flaws. A third needed component is to smooth out the seams 
between regional markets to allow power to flow more freely to demand.
    I am concerned that even if Congress could arrive at a conceptual 
agreement on how to address issues related to SMD, writing that 
agreement into legislative language could be next to impossible. 
Moreover, as markets develop, if a provision that was good policy when 
enacted needs to be changed down the road, we are all well aware how 
difficult making even the most common sense changes in the law can be.
    Our electric and gas systems can function under either a 
competitive or regulated cost-of-service model, but the existing ``one 
foot in the boat, one foot on the dock'' formula has been a recipe for 
disaster. The most likely outcome of Congress legislating on the SMD 
would be to perpetuate this untenable situation.
    In summary, Congress' first goal this year should be to promote 
electricity investment. You may not be able to resolve every policy 
issue facing the industry today, but the items outlined above must be 
addressed to help get this industry, and our economy, moving forward 
again.
    Thank you.

    Senator Thomas. Okay. Thank you, sir. I am interested in 
your comments particularly. You have spent some time in 
Wyoming, I understand.
    Mr. Sokol. Yes, sir, in Jackson.
    Senator Thomas. Good.
    Let me just ask a question and we will take maybe 5 minutes 
each on those. If PUHCA is eliminated, what--do you think that 
there are consumers and investors who will be protected? That 
is the reason it is there, to keep funny things from happening 
between outside investors. What is your reaction to that?
    Mr. Sokol. Well, PUHCA was enacted in 1935. And it had, I 
think, a very real reason to exist back at that time, when less 
than half of the United States even had utility regulation. And 
it dealt with some issues, corporate raiding that were taking 
place. Today we have a very different situation. Every State in 
the United States has a very effective public utility 
commission or public service commission. The industry is 
clearly regulated, both very effectively at the State level but 
also through the Federal Energy Regulatory Commission, the SEC, 
the Justice Department, as well.
    But what is really important to recognize is that PUHCA 
today really does not protect consumers. And in fact, the 
Oregon Public Utility Commission recently filed documents with 
the SEC saying that PUHCA will in fact harm the consumers in 
the State of Oregon, because it will not allow them to operate 
that utility in a way that they believe is in the best interest 
of consumers.
    What has happened over the last 65 years with PUHCA is that 
today we have some 5,000 very capable State regulatory 
employees, who are in fact protecting these assets. And yet 
people think that the mirage of 24 employees at the Securities 
and Exchange Commission in the PUHCA section are in fact doing 
that job. The reality is the States are doing it. But what 
PUHCA is doing is keeping, in our case, a AAA-rated company 
from investing in this sector.
    Senator Thomas. The States really do not have any authority 
over some kind of merger between companies that are in 
interstate commerce, right, merchant companies?
    Mr. Sokol. They do in regard to how those assets--as an 
example, when we purchased MidAmerican Energy, the utility in 
Iowa, they placed, the State of Iowa placed, restrictions on 
the capital structure, rate-making procedures, and every other 
element of that acquisition, or they would not let it go 
forward.
    Senator Thomas. What if the company that is purchased was 
in another State?
    Mr. Sokol. I am not aware of any State that does not impose 
capital restriction requirements, et cetera, on their utilities 
in an acquisition.
    Senator Thomas. Okay. You mentioned, sir, that the 
committee and the Congress should do something. Specifically, 
what do you think are the couple most important things the 
Congress could do?
    Mr. Svanda. Still on PUHCA reform or----
    Senator Thomas. No, just in general.
    Mr. Svanda. Okay. I believe that the list of items that I 
mentioned to incent investment would be the number one 
priority. I agree with nearly all of the comments made by the 
other people on your panel with regard to that being the 
highest priority. And it would certainly be where I would 
focus. And the list of items that would incent investment would 
be the first item.
    I think with regard to PUHCA reform, certainly reform is 
appropriate, so that investment is not deterred where it is 
appropriate. But as I mentioned in my oral comments, it needs 
to be done in a way that is sensitive to the lessons learned 
over the last couple of years, open access to information, 
assuring that States and other market monitoring entities have 
full access to all of the information that they need to make 
good assessments.
    Senator Thomas. If one of the reasons for the difficulty is 
access to transmission, is being able to move the power to the 
markets and so on, it does not look like incentives to invest 
would by itself be the answer.
    Mr. Svanda. I think that incentives to invest across the 
board in a balanced way that focuses on the need for 
transmission in many areas of the country, as documented in the 
Department of Energy's report on transmission, the $55 billion 
plus of investment that is necessary today, and that does not 
take into account economic growth when the economy turns and 
begins to move and those kinds of things, as well as balanced 
investment over into additional generating facilities where 
there are load pockets. And to enhance the technologies 
utilization of diversified fuel mix across the country are also 
important components.
    Senator Thomas. So the idea of incentives that could be 
provided here need to be aimed at different things, need to be 
aimed, for instance, at increased capacity and transmission, 
interstate transmission. So just the idea of depreciation, for 
example, would not by itself point where we want to go, would 
it?
    Mr. Svanda. I think that--no. I agree with you, Senator, 
that just across the board depreciation relief would not focus 
on those other national objectives that are really important 
that we worked to accomplish.
    Senator Thomas. So we need pretty much a policy and then 
follow it up with incentives to initiate and implement that 
policy.
    Mr. Svanda. That would be my suggestion, yes.
    Senator Thomas. I see.
    Senator.
    Senator Bingaman. Thank you very much.
    The main regulatory activity that is going on right now 
affecting this industry in a very direct way is the standard 
market design proposal that has come out of the FERC. And I 
understand they have been taking comments. They are going to 
issue a white paper in April.
    I think one theme that I heard from almost all of you, 
maybe all of you, is the need for more certainty in the 
regulatory environment in order to restore investor confidence. 
That is one of the justifications offered by Pat Wood at FERC 
for propounding the standard market design: that it will give 
people some certainty and consistency about what the rules are.
    And, I would just ask maybe each of you to comment as to 
whether you believe that, as a general matter, FERC is correct 
to be trying to enact or put in place a standard market design 
like this and whether it will achieve that and benefit the 
industry as a result.
    Mr. Sokol.
    Mr. Sokol. Senator, let me say that I think a standard 
market design that is developed through the FERC in cooperation 
with the States is a long term and an essential element to the 
infrastructure of this country on the energy side. If we had a 
comment for FERC, it would be to do it in a very cooperative 
fashion with the States, because there are certainly State 
issues that have to be coordinated effectively. But the reality 
is the transmission system in this country is unlikely to get 
the adequate investment that it needs without the limitations 
of PUHCA being dealt with and a set of rules established that 
both the States and the Federal agencies are in coordination 
with.
    Senator Bingaman. Do you believe both are important things 
to try to accomplish, the repeal of PUHCA and some adoption of 
some standardized rules and regulations?
    Mr. Sokol. I believe they are. I would caution only that 
with respect--that that should be done in a regulatory 
framework versus a legislative. Because whatever those rules 
are that the States and FERC agree with are going to change 
over the next 20 and 30 years. And legislation is very 
difficult to modify, where properly executed regulation, I 
think, is, in our view, the more appropriate place to do it.
    Senator Bingaman. Ms. Smith, did you have a point of view 
on this?
    Ms. Smith. Well, I basically agree with the other comments 
that the market would benefit from a comprehensive market 
design and more regulatory certainty. I think particularly in 
the sense that it might increase investment in transmission, 
which is really where the acute investment need is right now. 
You know, overlooking overall standard market design from a 
credit perspective, there probably would be some segments of 
the industry that might benefit and some that may, you know, 
suffer some losses. But overall, I do not think we see that 
standard market design in itself is a major credit driver for 
any of the companies in the industry right now.
    So I think overall it is a benefit, but we do not see it as 
a driver in credit.
    Senator Bingaman. Okay.
    Mr. Cassidy.
    Mr. Cassidy. Senator, I was careful in my testimony not to 
use those three little words, standard market design. But I did 
say that number one on my list is enabling FERC to put in place 
well-designed regional markets that have the characteristics 
that I outlined. And I do think that would go a tremendously 
long way towards shoring up confidence in the future of the 
industry.
    A number of my colleagues on the panel have talked about 
transmission investment. I just note that one of the 
characteristics of a well-designed regional market that I 
mentioned is a real-time spot market with congestion 
management. And what that congestion management piece means is 
that price signals are sent that tell investors where to make 
investments in the transmission system, so that a well 
functioning market provides its own incentives to build new 
transmission.
    Senator Bingaman. Very good.
    Mr. Silverstein.
    Mr. Silverstein. Yes. Notwithstanding everything else, I 
think part of the problems in the competitive model was seen 
that we did not attack transmission first and develop a strong 
and liquid transmission grid by which we have some idea of how 
electricity, which is a very complicated commodity, moves and 
understands the costs of moving it. And I think we went around 
this backwards, quite frankly, by opening up generation before 
we had approached the transmission problem.
    I really think an independent transmission network, 
regional as it starts out, is critical to get the most 
efficient structure that we can have and, as I said in my 
testimony, under any model that we adopt.
    I think a real issue that concerns me is the current 
conflict between States and Federal Government, because there 
is a lot of self-interest involved. And for some generation 
plans, that would benefit. Others would be penalized, when the 
transmission system is operating on a most efficient way. And 
so there are a lot of conflicts that are going on. But for the 
good of the overall country, a regional transmission system.
    As far as investment, there was some reference to that. I 
think transmission should be our first focus. It really needs 
to be. There is a fair amount of generation around right now. 
Certain pockets need generation. But we have to get this 
transmission issue right in order to have everything else be 
supported.
    And a final comment, if I could, on PUHCA. I do not know if 
full repeal is what is necessary. But one aspect of PUHCA, 
which is indicative of the problem, is, on one hand two 
companies that are not interconnected are restricted from 
merging by PUHCA requirements, which is needed for efficiency.
    On the other hand, market power is a restriction of two 
companies that are in the same markets of combining. And so 
there is a conflict between what we need to do and what PUHCA 
says we cannot do. And there is a court case on the AEP 
situation that exemplifies that. So I think we have to look at 
PUHCA and what it is restricting and solve for the issues.
    I think when we start with this, what are we trying to 
solve for? And we have to have an idea of where we are going 
before we start doing piecemeal actions, in my view.
    Senator Bingaman. Mr. Svanda.
    Mr. Svanda. Senator, as you might imagine, the State 
regulators have spent a lot of time thinking and working on 
this issue. And I need to first of all say that I need to give 
you a slightly schizophrenic answer. In Michigan, we have long 
been supporters of a move toward a standardized market. And we 
think the lessons of making all the railroad tracks the same 
gauge across the country is applicable here. We think that 
there are electronic versions of that same innovative approach 
of standardization, and that it would be beneficial to the 
electricity marketplace as well.
    We, Michigan, exist in a region that has generally taken 
that approach. And we point to Michigan and Indiana as a great 
example of how States with very different perspectives on 
retail open access come together on the issue of wholesale open 
access. And Indiana presents a State that has firmly committed 
to not moving to retail restructuring. Michigan has firmly 
committed to retail restructuring. And yet the two States are 
hand in glove on the issue of open access and standard market 
design development. So we are very supportive in our region and 
join other very good regions of the country in that support.
    Now I become schizophrenic because I am also here as the 
president of our national association. And the regions, for a 
lot of different reasons, and I have developed a pretty 
exhaustive list of why the regions of the country are 
different, how they are different, the fact that the regions 
did grow up with different institutions and different economic 
mixes, and a whole listing, as I said, of differentiators 
across the regions. And so for that reason, as NARUC's 
president, I need to let you know that NARUC has not taken a 
position with regard to standard market design, that there are 
regions of the country and States in the country that are very 
supportive. And equally, there are States and regions that are 
not supportive.
    And so as president, as I have tried to blend those two 
positions on the spectrum, I guess what I have become is an 
advocate of regional differentiation, that there are real ways 
to accommodate free wholesale markets and open access to the 
transmission system and still to respect the regional 
differences and the State differences that exist in the 
country.
    Senator Bingaman. Thank you very much.
    Senator Thomas. Thank you.
    Let me follow up just a little bit on that. In order to do 
it regionally, there have to be functional RTOs I believe. And 
that is not necessarily the case yet. How do you provide an 
incentive for that?
    Mr. Svanda. I think functional RTOs or some equivalent in 
the Western States, for example, Senator, there have been great 
efforts historically from governors of that region and other 
political leaders, as well as the institutions themselves, to 
establish many of the mechanisms that we today recognize are 
critical parts of RTOs.
    Now there are also components of RTO development that need 
work across the country. And I think there is a real 
recognition, for example, with regard to market monitoring, 
that it is an area where States and RTOs and the FERC and 
others share a common interest in assuring the strong 
development market monitoring mechanisms. So it is an area 
where we can all work, in spite of the fact that in the Midwest 
we have the Midwest ISO and PJM working to be the RTO in the 
West.
    There are different structures in the South and Southeast. 
There are different structures still in the Northeast corner of 
the country. In fact, just a couple of days ago, the Northeast 
initiated their version of a standard market design system 
across the northeastern States.
    Senator Thomas. Well, that is one of the reasons we had 
problems trying to put something together last year, is the 
different regions that had the same industries felt quite 
differently about the solution. And then you throw into that 
particularly the Bonnevilles and the public powers, who did not 
want to integrate particularly with their transmission into the 
investor owned. Then you have a real standoff. And we need to 
find a way to resolve that.
    Mr. Svanda. And, Senator, that is why I suggest that 
respect be given to those regional differences in the 
institutions that work well for them.
    Senator Thomas. Exactly.
    Mr. Svanda. I do not see that as a fatal impediment to the 
development of a standard market design. I have long said that. 
And I believe and I am hoping that FERC white paper in April 
will also reflect some of that type of thinking.
    Senator Thomas. There has to be some independence.
    Mr. Silverstein. You talked quite a bit about investment in 
the transmission. Who do you--who should have the ownership of 
that? I mean, transmissions have traditionally been put into 
place by the power providers and the generators who are not 
excited about having other people on there. And if you have a 
third-party operator, where do you get the investment? How does 
that work?
    Mr. Silverstein. Well, I think right now a transmission 
type of investment is perceived as a very attractive investment 
for the capital that is out there. The capital that Mr. Sokol 
suggests is out there, which it probably is. And Suzanne talked 
about there is capital coming into the industry.
    They want to invest in stable infrastructure investments. 
KKR just invested in a transmission line in Michigan. In this 
very uncertain and risk adverse time, that is one of the 
investments they are willing to invest in. What we need is some 
certainty.
    Senator Thomas. Why have we not investment in it then, if 
it is so attractive?
    Mr. Silverstein. Well, it is just beginning. One of the key 
issues on the sale price is the tax issue. There is a tax 
exposure to the seller. There is tax leakage. And they wanted--
there are some suggestions about some tax modifications to give 
them an incentive. FERC just provided incentives to move 
transmission into independent hands on a return equity basis. 
And I think this is going to start to move the process along.
    You know, this is an evolutionary process. But I do believe 
there is capital available for transmission investment. In my 
view, transmission looks like a lot like what the traditional 
integrated utility model looked like years ago, when it was 
considered a very stable, low risk investment.
    So I think the capital is there. We just need to set policy 
incentives.
    Senator Thomas. My question is: Who is going to be the 
third-party operator?
    Mr. Silverstein. Well, the third-party operator is probably 
a utility type or some other type of management that is totally 
independent of either the generation or the distribution. There 
are plenty of engineers and companies that will operate 
transmission. We have to demonstrate that they are capable of 
operating transmission. I do not think that is really the 
issue. The issue--to me, RTOs were always an interim step to 
the ultimate goal of having the totally independently owned and 
operated transmission system. I believe if we were setting up 
this model from scratch, that is the way it would be. The 
problem is this model is a legacy model that we are trying to 
transition to. And that is what is creating all the problems. I 
do not think there is an issue of----
    Senator Thomas. But the fact is, and the reliability 
council indicates, that for the next ten years there is only 
projected of 10,000 miles of additional transmission. And we 
have 160,000 miles. That is not likely to keep up. I mean, 
there is no indication that what you are talking about as 
investment is taking place.
    Mr. Silverstein. Well, I do not think it is because the 
capital is not there. I think there are impediments on building 
transmission. The focus has been on generation. I do not think 
that looking at what the plan is indicative of what the reality 
is. I think transmission capital is available. This is--the 
capital is not coming into the industry now to invest in 
merchant.
    Senator Thomas. But what happened, as you know, is the 
generators have been now gas fired, small generators built 
close to the market to avoid the transmission question. Were we 
in the coal business, we would love to transmit electricity. 
But we have not had an opportunity to have transmission.
    Mr. Silverstein. I can respond to that in that some of that 
generation that you said was built close to the market is not 
close to the market. That undisciplined capital built 
generation in a lot of places that are not going to access 
markets because the transmission constraints are there and are 
not available.
    Senator Thomas. But they are small. They are 100 megawatts 
or something.
    Mr. Silverstein. I mean, but I just think the impediments 
of not being able to get transmission sited, as you know, has 
really been the major constraint.
    Senator Thomas. Right.
    Mr. Silverstein. When you look at what you are talking 
about, constraints, we have to look at all the solutions, 
whether it is transmission, generation, distributed generation, 
conservation. In my testimony, that is why I talk about all 
those options have to be looked at to solve the problems. In 
not every case transmission is the answer. In not every case 
generation is the answer. There should be multiple solutions to 
every problem. And it is a decision that we have to make as to 
what that solution is, but not on a broad scale individually.
    Senator Thomas. Okay. Thank you.
    Senator.
    Senator Bingaman. One of the things we encountered when the 
crisis hit in California and the west coast was the buyers of 
power were having to essentially sign on to very high-priced, 
long-term contracts, or did sign on to high-priced contracts. 
And some of them are still trying to figure out how to get out 
of those.
    Now that power is cheap, do you have buyers going into the 
market, and are they able, under these circumstances, to lock 
in long-term supplies of power at low prices? I mean, that is 
something I would think would be happening and would be a good 
thing from the point of view of consumers and companies that 
need this electricity.
    Mr. Cassidy, is this happening, or am I--it just seems to 
me there is some logic in thinking it would.
    Mr. Cassidy. I agree with you, Senator, that there is logic 
to thinking that it would. And I would tell you that those of 
us in the generation and marketing sector are more than willing 
to enter into long-term contracts, because that provides us a 
level of financial stability that we would not otherwise have.
    I would say that on the consuming side, that we have seen 
less of that than I would have expected. And I think it may 
have to do with issues concerning just being gun shy from 
things that have happened in the market in the past.
    Senator Bingaman. Any of the others have any comments?
    Mr. Sokol.
    Mr. Sokol. Yes. What you are saying would make perfect 
sense and one would think it would happen. But in an industry 
where there is a lot of breakage and there are a lot of 
uncertain rules, what you saw happening up until California got 
into trouble, no one wanted to enter into any contracts. We had 
power available to sell into California prior to 2000. And the 
utilities would not even talk to you.
    The reason was prices were low. They thought they would 
stay low. The supply-demand imbalance occurred. People wanted 
to rush to make sure they would have adequate supplies. So they 
signed long-time contracts. A natural response occurred. More 
generation came on line. Prices came down. And today you do not 
see them signing long-term contracts. It is--there are a lot of 
perverse incentives out there that are creating some pretty odd 
situations.
    But to speak to your question at the introduction, we do 
have, I think, an excess of supply of generation in most parts 
of the country today, in some parts a significant oversupply. 
But there is no investment going on. And there are dozens of 
plants that have been stopped mid-construction. One that I am 
aware of, a thousand megawatt plant, was stopped 70 percent 
completed.
    So there is a real shifting set of dynamics. And if the 
economy does pick up steam and utilization of energy goes up, 
coupled with natural gas prices and the reality of the natural 
gas industry today, it will not very long in the future that 
you will be holding hearings on why are electricity prices so 
high again.
    Senator Bingaman. That has been a concern. And I tried to 
sort of allude to that in my opening comment about us having a 
hearing on the supply situation because when you look at the 
price of natural gas, where it is today, and you look at the 
lack of rainfall in the Northwest, and the lack of 
hydroelectric power coming out of the Northwest, it sounds like 
the same set of circumstances are coming into place that caused 
some of the crisis on the west coast a couple of years ago.
    I mean, I think what we are seeing here is you are not 
seeing people going ahead and signing on to long-term contracts 
as purchasers. It is a little like the way we deal with the 
SPRO around here. There is a big push to fill the Strategic 
Petroleum Reserve once the price the oil gets high, because 
people realize that this is a valued commodity and one we need 
to have a bunch of. And when the price drops down to $10 or 
$12, as it did a few years ago, you cannot get anybody 
interested in filling the SPRO because they assume it is not a 
big deal; there is plenty of it around.
    Mr. Silverstein, did you have a comment?
    Mr. Silverstein. I think it is three things. And one is 
human behavior, which you just described, that it seems like 
prices have to start going up before you incentivize people or 
get them to respond to long-term contracts. It happens in 
mortgages. When interest rates go up, there is a rush to do 
mortgages.
    I think it is the general uncertainty of the environment. 
And I think it is the credit quality concerns on the part of 
providers of the power, that there were contracts that were 
signed with providers in these last couple years that had to be 
broken, because they were not truly supported by economic and 
financial strength behind these companies.
    So we have this uncertainty and this risk adverse. What we 
are starting to see, because the gas prices go up pretty 
substantially here in the last three months or so, and if that 
continues, I think you will see buyers of power or purchasers 
of power starting to push towards signing longer term contracts 
to lock in the low cost supply.
    Senator Bingaman. Mr. Svanda, did you have a comment?
    Mr. Svanda. I did, Senator. And your interest in the 
description of long-term contracts is exactly what we are 
experiencing in Michigan. We have had, over the past couple of 
years, more than a couple thousand megawatts of new merchant 
plant development. And we have additional probably 3,000 
megawatts of merchant plant coming on line fairly shortly, 
including some very significant plants up to 1,100 megawatt in 
size generating plants. And they are based on long-term 
bilateral contracts and arrangements with third parties for 
marketing and those kinds of things.
    So it, again, is one of those areas where, I think if you 
build the crutch kind of harmonized regulatory climate from all 
of the parties involved, that you can incent investment and 
encourage it to move forward.
    I think that ties into the question that you started 
initially with, and that was are we building enough on the 
supply side. And I do think that work needs to be done there. 
As I mentioned in my comments, the demand for electricity is 
down considerably with the slowed down economy. We are not 
testing our system at all.
    If we were in fact experiencing a robust economy today, we 
would be wondering why we had not taken advantage of the time 
available to us to invest and build transmission and generation 
support and environmentally sensitive and diversified fuel 
sources to support that vibrant economy.
    Senator Bingaman. Thank you very much.
    Senator Thomas. Welcome, Senator Johnson. Would you care to 
make a statement or ask questions?
    Senator Johnson. Thank you, Mr. Chairman. I will submit a 
statement. I apologize for being late to this hearing. I, as so 
many members do, I have just a lot of things going on 
simultaneously here. And I will submit a statement for the 
record.
    Senator Thomas. It will be put in the record.
    [The prepared statement of Senator Johnson follows:]

Prepared Statement of Hon. Tim. Johnson, U.S. Senator From South Dakota

    Mr. Chairman, thank you for holding this important hearing today.
    This is a difficult and critical time for electricity providers and 
the energy industry. Our economy and the nation is directly reliant on 
a healthy electricity system. Our providers do a great job of keeping 
the country wired and bringing power where is it is needed. Providing 
affordable and reliable power to consumers has been one of the biggest 
reasons that the nation has progressed in the last century. In my part 
of the country, the electrification of rural areas in the early to mid-
1900s literally brought the modern world to these spots and enabled 
states like South Dakota to grow and prosper.
    However, it is clear that this is becoming far more difficult. The 
demand for electricity is growing rapidly, faster than most providers 
can keep up with it. The blackouts in California, the collapse of 
Enron, some failed investments and the slow economy have adversely 
affected utilities and other electricity providers. Moreover, the 
entire energy system is strained. The increasing volatility in gasoline 
and diesel prices, the growing tension in the world from the terrorist 
attacks, and the possibility of war with Iraq have affected all of us. 
It is clear that we need to bring stability and more certainty to the 
situation so that we don't face shortages and blackouts in the future. 
Our economy depends on it.
    The main issue facing utilities and other electricity providers is 
the lack of access to capital. Many are reluctant to invest when there 
is so much uncertainty in the future. Perhaps nowhere is this more 
acute than in the transmission system. In many parts of the country, 
the transmission system is balkanized and literally maxed out. The 
constraints cause more pressure and can lead to blackouts and people 
not receiving the power they need. Improving the ability of the 
transmission system to move power from one area to the next is the key 
to making the system improve with the demands of the 20th century. We 
need to search for ways to encourage more building of transmission, and 
for the creation of innovative technologies to move power. As demand 
grows, so does the need for a modern system to handle the nation's 
needs.
    Congress has looked at many options to aid the system and more will 
likely be considered as part of an energy bill or as stand-alone bills. 
These are very difficult and complex problems that we are addressing. 
It is important that all parties and regions participate in the 
discussion and work toward solutions that benefit everyone. The nation 
depends on a stable and modern electricity system and everyone must 
work together to maintain that goal.

    Senator Johnson. Let me ask just briefly, however, to Mr. 
Sokol, I noticed in your full investment agenda that you 
included extension and expansion of the renewable energy tax 
credits. Is that something that is of interest only to the 
renewable side of your business, or does your utility see value 
in that, also?
    Mr. Sokol. Thank you, Senator. Our utility does see value 
in that. To be fair and honest, it predominantly driven by the 
States that we operate in as a request of the magnitude, 
because currently that production will cost a premium. But we 
do think that, as a broader analysis of the generation mix, it 
makes sense to have as much renewable as is reasonably 
affordable.
    Senator Johnson. Let me ask Mr. Sokol or any other members 
of the panel who would be so inclined, a concern I have about 
attracting more investment into transmission systems, how can 
we assist with that? And also the connected question of whether 
the lack of investment affects the ability to create new 
technologies for transmission, and whether that is in fact one 
of the consequences of the lack of our inability to attract 
capital right now.
    Mr. Sokol. I think just to start a comment, the chairman of 
NARUC, who is here, made a comment earlier that one way is, and 
it is a great term, harmonizing State and Federal regulation is 
probably the most significant issue for transmission 
investment.
    Secondly would be an issue that I sound like a broken 
record on, but PUHCA limitations, which is you have to allow 
people to own more than 4.9 percent of something, or you will 
not find the level of investment that I think you are looking 
for.
    But the harmonization of State and Federal rules, whether 
that is a cooperative or regional SMD or some other process, is 
essential, I think, for this industry.
    Senator Johnson. Any other comment on that issue?
    Ms. Smith. I would just say that some of the incentives 
that have been structured recently with independent ownership 
of transmission are, from a credit perspective, are good, 
because they do offer predictable, reliable returns for 
transmission owners and probably would be a good incentive for 
investment. A comment has been made already that the 
constraints for investment is probably not capital constraint. 
And I agree with that. It is not a shortage of capital. It is 
really a question of siting is one of the bigger issues.
    Senator Johnson. Mr. Silverstein.
    Mr. Silverstein. I just think independent transmission, if 
it is in the hands of independents, there is a better shot of 
those owners being in different technological achievement and 
investment. Because they are in the business to make that 
system as efficient as possible, indifferent to what it does to 
the generation side of the business. And that is why I believe 
under any model transmission is better off in independent 
hands.
    Mr. Svanda. Senator, I would just speak to your interest in 
technological development and investment. And in earlier 
comments I did make the claim that that is one of the most 
important things that we could be doing, that we do have, as a 
national grid, a fairly dumb system based on mechanical 
switching systems out of our industrial past, and that we do 
need to be upgrading. We need to make that system smart for 
reliability and homeland security and a lot of other reasons. 
And there is not any better way than investing in technology.
    There also is not any better way to take advantage or 
rights-of-way and other constrained land areas than by 
intensifying the utilization. And we can only do that through 
technological advance.
    Senator Johnson. Right.
    Thank you, Mr. Chairman.
    Senator Thomas. Thank you, sir.
    Commissioner, let me say that some utilities have described 
the dilemma they face in satisfying State regulators and the 
Federal Regulatory Commission. And this tends to undermine in 
their view some of the costs of recovery. The Supreme Court, as 
you know, is hearing a case of Louisiana Public Service 
Commission. To what extent do you think the State rate makers 
authority has to do with financial distress and resistence to 
investing?
    Mr. Svanda. Well, certainly State regulators--and as I 
indicated with your earlier comment--can contribute 
significantly to harmonizing the total environment that we 
operate under. We can--we can ask the State regulators across 
the country to meaningfully ensure that they are contributing 
to stability and an investor climate that is appropriate. We 
cannot predict how they will respond as individual 
commissioners or as individual States to that appeal.
    But the issue has been elevated for every State 
commissioner across the country in terms of the importance of 
representing a stable and reliable environment for investment. 
One of the fortunate experiences that we, as State regulators, 
have is that we do view the capital markets from a few 
perspectives, including this one and telecommunications. And we 
see some real similarities in terms of how investment patterns 
have developed recently. And I think we are serious across the 
country.
    Senator Thomas. I guess my question is, have they been part 
of the obstacle to moving forward? Have regulators been part of 
the problem?
    Mr. Svanda. In truth, yes, regulators can be part of the 
problem. They can also be part of the solution. It depends on 
how they approach their particular job.
    Senator Thomas. Okay. Good.
    Mr. Sokol. If we get rid of PUHCA, PURPA, do we have 
sufficient resources and organizations to outlaw the practice 
of round trip trading, false information, which is something 
that apparently has been happening, at least in the west coast 
system? Do we have adequate price and transmission visibility, 
openness? What do you think?
    Mr. Sokol. Well, I think there are two different questions 
there. In fairness, I would argue, Mr. Chairman, that PUHCA has 
nothing to do with any of those items. And I think in truth it 
does not.
    I would respond to an earlier comment or question that you 
had asked. Customer and consumer protections, those that do 
exist in PUHCA, from our standpoint and I think from the 
industry's standpoint, should be kept, whether they are kept as 
a revised PUHCA or in some other area. Because if the State 
regulators have access to books and records and proper 
availability of information, I think in the 14 States we 
operate in, they do a very effective job of regulating.
    As far as round trip trading and that, as a company, we 
think that the derivatives industry and the energy sector 
should be regulated. Trading should be regulated, just as the 
financial trading industry is. I think a great deal of the 
chicanery and nonsense and illegality that took place would 
have been avoided if, in fact, there had been both oversight 
and the fear of retribution or penalty.
    So--but PUHCA certainly did not stop Enron from doing what 
they were doing or we are doing or a number of other players. 
And----
    Senator Thomas. Well, but the question is: If you have 
investment that is around different places and so on, PUHCA, 
you have some potential to do some things that are unusual.
    Mr. Sokol. True, although I would point out that of the 
Enron assets that have any remaining value, they were those 
assets that were protected by either State or Federal 
regulation, which are their pipelines or their utilities.
    Senator Thomas. Ms. Smith, I think you indicated that you 
thought more regulation was better than the marketplace. Is 
that what----
    Ms. Smith. Well, I was making the point that for credit 
quality, where regulation provides a predictable return, that 
is good for credit. But in terms of whether more regulation is 
necessary, you know, I think it would be in many cases better 
to have more for----
    Senator Thomas. Well, that, of course, is--this is the 
whole situation as to where we are. We came from a regulated 
industry, totally regulated industry. And now we are finding 
one where generation, at least, is no longer regulated. And we 
are going into a marketplace. And so do we not have to deal? I 
think if we want to be in a marketplace, which I suppose most 
of us do, then do we not have to deal with that?
    Ms. Smith. Absolutely. I think you have to look at having 
clear market rules, probably better oversight of the regulatory 
system. I mean, what we are saying is that the marketing and 
trading function, in particular, needs to be overhauled and 
would benefit from better oversight. That is one part of it. 
There are other, you know, overhaul issues, I think, that are 
related to that. But oversight is one of them.
    Senator Thomas. Someone might suggest that, frankly, we do 
not have much of a policy, number one, which we should have. 
And number two, our currently regulatory thing has not kept 
pace with the change in the industry.
    Ms. Smith. Right.
    Senator Thomas. We seem to be resistant to doing that, even 
though the changes have taken place to a large extent.
    Ms. Smith. We have also noted that, you know, regulators 
generally have the jurisdiction and the authority to take 
actions, particularly on a State level. But they have been 
reluctant to do that. You have situations, like in California 
and Nevada, where I do not think--where the regulators could 
certainly have acted, but they did not. Or similarly in the 
State of Minnesota, with the situation with Excel Energy and 
NRG, you know, maybe now the regulators are looking at trying 
to protect the utility from the activities of its unregulated 
business component. But a crisis really had to occur before 
that took place.
    So there is a question of whether the regulation is 
preemptive or reactionary. I think more preemptive regulation 
would benefit credit quality as well.
    Senator Thomas. Most of us want a minimum of regulation, 
but it has to be enough to do the job. And we certainly come 
from an industry where the generators and their distribution 
systems were all integrated. And there was much less 
regulatory, intrastate regulatory, things that had to happen.
    Senator.
    Senator Bingaman. Yes. Let me just question on this. Mr. 
Sokol, you have indicated that were it not for the existence of 
PUHCA, you would be perhaps interested in looking at purchase 
or acquisition of the Portland General Electric Company, or at 
least that is a possibility. So PUHCA is keeping you from doing 
that. And I understand your point of view, and I have agreed 
with you that PUHCA has outlived its usefulness in that regard.
    But those who oppose the repeal of PUHCA say that without 
PUHCA Enron would not have just owned PGE, Enron would have 
owned 10 or 20 utilities around the country. These guys were 
highrollers. They had a stock price that allowed them to buy 
anything they wanted, essentially. So what do you believe we 
would have to put in place to properly guard against that 
circumstance of a company coming in, a company that did not 
have the financial soundness to be doing that, and wind up with 
a whole lot more in-stress utilities at the end of things than 
we have under what happened this time?
    Mr. Sokol. Well, I think two things. First of all, Enron 
was actually trying to sell Portland General for 2 years prior 
to them going bankrupt. And the reality was they were trying to 
leave an asset heavy industry. But the reason Portland General 
still exists today as a utility and has its own financial 
capability is the fact that the State ring fenced Portland 
General from the rest of Enron and required that it stay that 
way.
    None of the States that we operate in would handle that any 
differently. I mean, they required--and in fact the State of 
Iowa, even with Berkshire as the 80 percent economic owner, 
required the same thing, that that utilities capital structure 
be rigidly established.
    I think that between the Justice Department and the FTC 
under the same provisions that any other industry would 
consolidate under, which would protect for market manipulation 
or excessive market power, you would have those today in the 
United States as we have for every other industry. So from the 
standpoint of a company acquiring two or three, I think the 
protections, other than PUHCA are the existing Federal 
requirements for antitrust and then State regulatory body 
oversight for that same issue.
    Senator Bingaman. You do not think FERC should have 
additional authority to oversee and intervene in case of 
mergers and acquisitions?
    Mr. Sokol. Our company's policy is we do not have a problem 
with FERC having that. We would be willing to support that. 
Having reviewed what the other Federal agencies have already as 
a right, it would seem duplicative. But from our perspective, 
it does not matter.
    Senator Bingaman. Okay. I will stop with that, Mr. 
Chairman. Thank you.
    Senator Thomas. Senator Johnson, any more questions?
    Senator Alexander.
    Let me just finish with one here, Ms. Smith. We do not want 
to let you get away too easy here. The credit rating for many 
energy companies has been reduced, some below the investment 
grade. Agencies have been accused of reactionary downgrading 
and changing valuation criteria. How do you react to that?
    Ms. Smith. Well, I think there are various reasons why the 
credit decline has occurred. And, you know, they really have 
very little or nothing to do with the actions of Standard and 
Poor's directly or any credit rating company. The presence of 
ratings triggers, in particular, has been a problem and caused 
acceleration in credit downgrades, because the companies are 
particularly vulnerable, operating at a low investment grade 
ratings triggers.
    Because of liquidity, really severe liquidity, issues, we 
have taken a look at, you know, at the ratings very carefully. 
Liquidity has become a very important component of ratings. It 
always has been. But I guess our emphasis has changed a little 
bit.
    But we have not changed in any fundamental way our criteria 
for evaluating companies. Criteria is always evolving. But it 
has not really caused any slide in creditworthiness as it 
applies to a particular industry or the electricity industry.
    So I think that the comments that we have been reactionary 
are misplaced, in that we are responding to really a serious 
decline in industry fundamentals and financing practices that 
have really caused the decline, more than any action that 
rating companies have taken.
    Senator Thomas. Thank you.
    I am ready to close, Senator, if you have nothing more.
    Thank you all for being here. And I hope you will stay with 
us during the policy efforts and have some input as to how we 
can work on making these problems work out a little better. I 
think that is our challenge.
    Thank you all for being here.
    [Whereupon, at 11:25 a.m., the hearing was adjourned.]

                               APPENDIXES

                              ----------                              

                               Appendix I

                   Responses to Additional Questions

                              ----------                              

                           MidAmerican Energy Holdings Co.,
                                         Omaha, NE, March 18, 2003.
Hon. Pete Domenici,
Chairman, Senate Energy and Natural Resources Committee, Dirksen Senate 
        Office Building, Washington, DC.
    Dear Senator Domenici: In response to your March 5 letter to me, 
enclosed are my answers to the list of questions that have been 
submitted for the record in connection with my March 4 testimony before 
the Senate Energy and Natural Resources Committee regarding financial 
conditions in the electricity markets.
    Please do not hesitate to contact me if you or other members have 
any additional questions. Once again, I appreciate your giving me the 
opportunity to discuss my views on these important issues.
    Sincerely,
                                            David L. Sokol,
                                                  Chairman and CEO.
                Questions Submitted by Senator Domenici
    Question 1. I would like each of you to explain what you think the 
primary factors are that have led to the current financial situation in 
the electricity sector.
    Answer. I believe there are four primary factors, in addition to 
the recessionary economy we are facing:
    a. Congress introduced wholesale competition into this sector with 
passage of the Energy Policy Act of 1992. This competition increased 
the risk profile and complexity of the industry, thus diminishing the 
sector's historic position as a safe haven for small investors. 
However, Congress did not eliminate PUHCA at that time, so it provided 
no mechanism for large investors who are able to ride out volatility to 
enter the marketplace or to invest in the market. As a result, 
individual ownership of utility equity has declined rapidly, often 
replaced by debt.
    b. The failure of Congress, FERC and the states to reach agreement 
to harmonize the regulatory environment has created a level of 
uncertainty that has discouraged investment and driven up the cost of 
debt. Investors won't invest in regulated assets unless they are clear 
as to how those investments will be recovered. Investors will also 
hesitate to invest in competitive generation assets if it appears that 
Congress will turn away from wholesale competition.
    c. Many companies made honest investment mistakes, failing to 
appreciate the cumulative impact of numerous companies pursuing overly 
aggressive growth strategies at the same time. That resulted in a glut 
of generation, and since almost all the new generation is gas-fired, 
the situation may get worse. In addition, a number of companies 
overpaid for international assets and trading platforms.
    d. It is difficult to overstate the negative impact on the industry 
of the Enron collapse and the revelation of other examples of severe 
corporate misconduct. These types of situations are by no means unique 
to our industry, but the fact that Enron was the first and the most 
high profile company to collapse under its own accounting fictions and 
excesses has resulted in a disproportionate impact on the electricity 
and gas industries.
    Question 2. To what extent do you think the challenges facing the 
electric industry are related to the general downturn in the economy?
    Answer. Electricity demand is closely tied to GDP growth, trailing 
GDP growth by about 1% (except for peak demand). Although residential 
electricity demand has remained relatively consistent over the past few 
years, there has been an actual decline in electricity use in the 
industrial sector. The general downturn in the economy has thus 
undoubtedly contributed to the set of problems caused by the excess 
supply of generation in some regions, but our weak economy is actually 
masking the longer term structural problems our industry faces. 
Infrastructure growth continues to lag far behind load and 
transactional growth. I share Senator Bingaman's concern that in a few 
years we may see the conditions that contributed to the Western energy 
crisis recur.
    Question 3. Can you give us some perspective on other industry 
sectors and whether they are facing challenges similar to those 
confronting the electricity sector?
    Answer. As competition has been introduced into the electricity 
sector, it has begun to confront the same market risks common to other 
capital-intensive industries. Like steel, chemicals, paper, and oil and 
gas, the electricity sector must manage business cycles, supply costs 
and risks, technological changes, and susceptibility to boom and bust.
    The decline in the industry's credit outlook has resulted in part 
from the beginning of deregulation. Electricity's traditional monopoly 
status, with a captive base of customers, provided the industry with 
strong credit quality and easy access to capital markets. The advent of 
competition has shifted risks to lenders and away from ratepayers. That 
certainly comes as no surprise, as regulation has always supported 
credit strength.
    Competitive industries, of course, need customers, and that is 
where the partial deregulation of the electric industry has resulted in 
challenges that are different from other industries. Regulatory reform 
in our industry has proceeded more slowly and more narrowly than in 
other industries. As a result, the factors that support competitive 
markets still do not broadly exist, as our industry continues to have 
``one foot in the boat, one foot on the dock.'' This, in turn, has 
resulted in redistribution of risks and market distortions that 
continue to plague our industry. For example, competition generally 
ends at the wholesale level instead of reaching the retail level. In 
addition, retail rates in some markets are mandated to drop, thus 
benefiting consumers while dramatically shifting investment costs from 
ratepayers to investors and lenders.
    Question 4. The credit rating for many energy companies has been 
reduced, some to below investment grade. The credit rating agencies 
have been accused of reactionary downgrading and changing valuation 
criteria. How do you respond to those allegations?
    Answer. There may be some degree of overreaction, but overall I 
believe the agencies are responding responsibly to market realities. 
Blaming the rating agencies for the industry's problems is more blaming 
the messenger than acknowledging that many companies made mistakes.
    Question 5. Do you thing that developers overestimated the demand?
    Answer. Generation developers clearly overestimated demand, and I 
agree with Mr. Silverstein that the financial community became 
undisciplined in many cases. In such a high capital industry, it will 
take years to unwind some of these mistakes.
    Question 6. Are the problems now faced by competitive generators 
due to overbuilding?
    Answer. Overbuilding and the lack of regulatory certainty are the 
two main problems facing competitive generation. We clearly have 
overcapacity in some regions of the country, and the fact that we 
haven't settled the regulatory groundwork or made any inroads in 
increasing transmission infrastructure makes matters worse. Some 
investors might be willing to acquire significant stakes in generation 
if the roadmap to large regional transparent markets were more clear. 
With transmission constraints and regulatory uncertainty, investors 
can't count on even the long-term value of these assets.
    Question 7. Is there an over abundance of generation supply? Is it 
concentrated in certain regions of the country? How long will it last?
    Answer. In the late 1990s, there were regions of the country that 
needed or were close to needing new capacity to meet consumer demand. 
In response to the demand, approximately 150,000 MW has been 
constructed since 1997, and another 55,000 MW is scheduled to come 
online this year.
    The generation supply situation today is not uniform throughout the 
country. California and southern Nevada, New York, southern New 
England, and parts of the upper Midwest will be the first regions to 
face renewed supply constraints, while Texas and the mid-Atlantic have 
the most excess supply. Nationwide, it is estimated that the average 
U.S. reserve margin will peak at 34% in 2004. How long the 
overabundance lasts will depend in part on the economy. Our best 
estimate is that it will be five to ten years before prices will come 
to the level that would justify building new plants. Plants today are 
selling at $50-$200/kw, while the cost of construction is about $600/
kw. It will take at least five years before forward margins would 
generate a return on investment that would warrant a $600/kw 
investment.
    Question 8. What is your response to this potential issue of 
insufficient natural gas supplies and increased dependence on LNG?
    Answer. The adequacy of natural gas supply and infrastructure is 
one of the most critical long-term policy issues facing the country. Of 
the new 144 gigawatts added between 1999 and 2002, 138 were natural 
gas-fired facilities. The percentage of generation from natural gas is 
projected to increase from 17 percent in 2001 to 29 percent in 2025, 
including generation by electric utilities, independent power 
producers, and combined heat and power generators. While I understand 
the attraction of using natural gas for generation because it is clean 
and efficient, I am concerned that this trend may lead us into a supply 
crisis for natural gas and require increased dependency on foreign 
imports of LNG.
    This winter, for the second time in the last three years, natural 
gas prices have soared, straining family budgets, disrupting 
manufacturing activities, and placing further pressure on agriculture. 
The fact that the system can't absorb a moderately cold winter during a 
slow economy demonstrates how fragile the situation is. Congress needs 
to adopt a multi-pronged approach to this situation. First, we must 
obtain more supply. Even at current prices, we are depleting supply 
sources faster than we are drilling new wells. Some of the most 
promising areas for new development have been placed off-limits by 
federal policy, and exploration in other areas is severely restricted. 
The United States should not have to import our way out of this 
problem, given North America's domestic reserves. And LNG can only be a 
partial answer.
    The second element of problem is on the demand side. The 
environmental policies of the previous Administration resulted in 
almost no new coal generation, and we still do not have the regulatory 
certainty for investors to move forward with new nuclear projects. We 
need to identify responsible approaches to maintaining coal and nuclear 
generation (which together account for almost 80% of U.S. generation), 
in order to ease demand pressure on gas.
    Third, we also must make more use of renewables and CHP (combined 
heat and power) through long-term extensions of the production tax 
credits that help offset the high capital cost of renewable 
development. I believe we can increase the percentage of renewables in 
the generation mix to 6-8% by 2020 without mandates or negative impacts 
on consumers.
    Question. Between January 2000 and July 2002, more than 90,000 MW 
of capacity were delayed and more than 86,000 MW of capacity were 
cancelled. The costs associated with these delays and cancellations are 
significant. For example, there are reports that merchant generators 
must refinance $90 billion of debt over the next four years, with $30 
to $50 billion coming due in the next two years alone.
    9. Do you think that these companies will successfully refinance 
their substantial debt? Or should we prepare ourselves to see a series 
of generating assets fall into the hands of banks?
    Answer. A number of companies that were overly aggressive in 
generation expansion face either bankruptcy or complete restructuring. 
The number ranges from 6 to 12 depending on the overall health of the 
economy and natural gas prices. A substantial amount of generation will 
be put up for bid and some assets will undoubtedly end up in the hands 
of financial institutions. While I believe that some huge mistakes were 
made by companies that followed the merchant generation model, 
Congress, FERC and the states should work to harmonize policies on 
market structure and transmission development so that the majority of 
this investment can ultimately be put to beneficial economic use.
    Question 10. Given these financial constraints, will the merchant 
generator model survive?
    Answer. The pure merchant generation model may not survive, but 
that should not mean that competitive generation doesn't survive. If--
and hopefully when--PUHCA is repealed, it will be possible to build 
electric companies with geographically diverse asset mixes that include 
both competitive generation and regulated distribution and can be owned 
by any willing investor.
    Question. Energy security requires a reliable, efficient 
transmission system. Some reports claim that annual investment in 
transmission has declined by almost $120 million a year for the past 25 
years. The North American Reliability Council found that transmission 
investment over the next 10 years will grow by little more than 10,000 
miles. The transmission system consists of 158,000 miles, so that is 
about a 5% increase.
    11. What are the reasons for this lack of investment in 
transmission infrastructure?
    Answer. See answer to question 14, below.
    Question 12. What potential solutions should be considered to 
improve this situation?
    See answer to question 14, below.
    Question. Over the past decade, transmission service policy has 
required increased open access to promote competition in generation 
supply. Generation supply has expanded, sometimes exceeding consumer 
needs; transmission expansion has lagged.
    Are there immediate consequences for this failure to expand 
transmission?
    Answer. See answer to question 14, below.
    Question 14. What do we need to do to ensure adequate transmission 
for the future?
    Answer. There are three major problems with getting new 
transmission built: (a) regulatory certainty in terms of cost recovery; 
(b) procedural barriers to siting new transmission; and (c) PUHCA's 
limitations on investment.
    Large multi-state projects that provide dispersed regional benefits 
will not get built until the regulatory environment is more clear. The 
procedural and environmental barriers to building new transmission can 
also be enormous, with some needed projects languishing for decades. 
This is particularly true of renewable projects, which are location-
specific and therefore cannot be flexibly located. The environmental 
community simply must become more responsible, given the massive 
benefits in terms of clean air and avoided emissions that a robust and 
efficient transmission grid will provide.
    Finally, PUHCA is making the financing and governance of 
independent transmission companies extremely challenging. The ownership 
of transcos must be heavily dispersed to prevent investors from 
triggering PUHCA's limitations. It is difficult enough to assemble the 
capital and management structure to establish one of these entities 
without PUHCA. It's that much harder to do so 4.99% at a time, which is 
the limitation imposed by PUHCA.
    Based on our conversations with the financial community, MEHC and a 
number of other electric companies have developed an agenda for 
addressing the capital crisis that includes four legislative 
recommendations on transmission:
    a. Enact some form of the transmission spin-off language so that 
utilities can meet their Order 888 requirements.
    b. Decrease the depreciable life of transmission assets to a more 
reasonable level.
    c. Streamline transmission siting by coordinating federal agency 
actions and establishing cooperative regional organizations that are 
ideally supported with federal authority; and
    d. Replace or eliminate PUHCA.
    Finally, Congress should work to encourage harmonization of the 
federal-state relationship in order to smooth the transition to open 
competitive wholesale markets.
    Question. FERC recently proposed incentive transmission rates for 
entities that transfer their transmission assets to RTOs (Regional 
Transmission Organizations) or Independent Transmission Providers.
    15. Do you think that this is an effective inducement on companies 
to transfer transmission assets to RTOs?
    Answer. This is one of a number of incentives that would serve as 
effective inducements. Others would be to repeal PUHCA and to harmonize 
state and federal regulations.
    Question. Many claim that difficulties in transmitting siting and 
permitting procedures are a major reason why transmission development 
has not kept pace with need.
    16. What are viable solutions to this challenge?
    Answer. From a strictly operational standpoint, I would recommend 
the natural gas pipeline model. This has worked well to facilitate new 
infrastructure development. At the same time, I recognize the intense 
political passions that arise from any discussion of federal siting 
authority, particularly in the West. Regional approaches are needed, 
but I understand these are constitutionally difficult to implement. An 
evolutionary approach that relies on joint federal-state boards (or 
interstate compacts) and leaves specific siting decisions in the hands 
of the states may be the best Congress can do. Congress must, however, 
do something.
    Question. The electric industry has been evolving toward a more 
competitive model, specifically in wholesale power market. Given where 
we are today, some seriously question whether this is the model that 
will best serve consumers and our national interest.
    17. Do you think that increased competition in the electricity 
market promotes reliability, economic pricing and environmentally safe 
power?
    Answer. Given sound market rules that conform with fundamental 
economic principles and the technical realities of the industry, 
wholesale electric competition should produce lower prices relative to 
regulation, more innovation, and higher levels of reliability. As has 
been noted elsewhere, the DOE's most recent estimates are that 
wholesale competition saves consumers $13 billion annually. Well 
structured markets in the mid-Atlantic and Texas are providing 
substantial consumer savings, even with rising fuel costs. Our economy 
simply cannot afford to throw away these benefits. In the post 9/11 
world, one of the greatest challenges our industry faces is not only 
increasing system redundancy to insure reliability, but also increasing 
overall reliability by several orders of magnitude. If we are to do 
this, and do it affordably, we cannot simply rely on old-style 
regulation that provides little incentive for innovation.
    Question 18. Competition in electricity brings volatility in 
prices, but does it also bring lower prices for consumers?
    Answer. There are two main ways to reduce volatility: First, build 
a robust transmission grid supported by clear market rules, so that 
willing buyers and sellers can be brought together over the widest 
possible area. Second, establish regional capacity markets that spread 
out the cost of meeting demand peaks more evenly. Critics of the SMD's 
requirement that RTOs establish some form of regional capacity markets 
are off-base. This is not an intrusion on state authority, but the best 
way to insulate states in a region against the failure of another state 
to meet its supply obligations.
    Question. While much of my focus has been on expanding the physical 
power infrastructure, I would also like your input on the following.
    19. What are other effective ways to improve our energy 
infrastructure that do not include the expansion of generation or 
transmission facilities?
    New emerging technologies such as fuel cells, distributed 
generation, CHP, high conductivity transmission, and metering systems 
that support demand-side solutions all should play a role in meeting 
the country's energy and environmental challenges. Last year's energy 
bill included broadly supported bi-partisan approaches on these issues. 
This is one more reason why Congress must leave behind adversarial 
gridlock and pass an energy bill.
    Question 20. What kinds of incentives are needed to encourage 
energy companies to invest in advanced technology for both generation 
and transmission?
    Taking the legislative and regulatory steps to create vibrant 
competitive wholesale generating markets should provide the major 
incentive for generators to invest in new technology. For renewables, 
extending the Section 45 production tax credit and expanding it to 
cover all renewables will help offset high capital costs. On 
transmission and generation, regulatory certainty of cost recovery for 
advanced technology investments and ratemaking structures that reward 
these investments are the most important components.
                 Questions Submitted By Senator Bunning
    Question 21. While there is currently an abundance of electricity 
generation, if demand continues to increase steadily and building of 
new electricity generation continues to remain stagnant, we are 
expected to face under-capacity of electricity in the very near future. 
Besides repealing PUHCA (Public Utility Holdings Company Act), what 
else do your propose would spur investment in new generation to meet 
future demands?
    Answer. For the most part, market forces should govern the 
generation market. However, we also need to recognize that electric 
generation is part of an integrated network system. It is a high 
capital, large footprint, long-lead time in development industry that 
has to deal with fairly unique environmental challenges.
    Because of these characteristics, there are a number of policy 
challenges that generation faces:
    a. As emissions limitations become increasingly stringent, Congress 
should look to provide incentives to the industry to keep available 
capacity on-line while meeting these new environmental requirements. 
Depreciation schedules for pollution control equipment installed on 
power plants built after 1975 are 20 years, as opposed to 5 years for 
pre-1975 plants. Congress should consider reducing the post-1975 class 
depreciation schedules to facilitate emissions reductions that will 
have broad social benefits.
    b. Any legislation that improves transmission siting will provide a 
large, indirect benefit to generation, particularly renewable 
resources. One of the greatest challenges we face with our geothermal 
operations in California is the need for a more robust transmission 
system to bring power generated in a remote location to load centers. 
The same problem can hold true for conventional projects such as mine 
mouth coal.
    c. Although MidAmerican owns only a minority share in two nuclear 
units, I also would strongly encourage Congress to finally finish the 
job of reauthorizing the Price-Anderson Act.
    d. Utilities are also facing increasing demands at the state level 
to increase their share of renewable generation. Extending and 
expanding the Section 45 tax credits to all renewables will help bring 
these resources to market at affordable rates for consumers.
    e. On the regulatory side, the more certainty we have in areas such 
as contract sanctity, the more likely the financial community is to 
return to the industry.
    f. Finally, FERC's ongoing regulatory efforts should ensure that 
adequate price signals are sent to develop regional capacity markets. 
This will have the advantage of reducing price volatility and diminish 
the tendency of the industry to go through boom and bust cycles.
    Question 22. On January 15, 2003, FERC issued a Proposed Policy on 
Transmission Rate Incentives to force structural change in the 
electricity market. FERC investigations have shown that utilities have 
turned away transmission customers--even though space was available on 
utility lines--in order to eliminate competition for power sales by 
their own affiliated generators. This practice in effect deprived 
consumers of access to lower cost power. FERC has said its proposed 
order will reduce the sway held by utilities over the grid, and thereby 
help consumers. Do you believe that the proposed order will help 
consumers have lower rates?
    Answer. I believe the overwhelming majority of utilities operate 
their transmission systems consistent with FERC Order 888 and the 
principles of wholesale open access. The problem has been that it is 
difficult to ensure that this is being done due to the real-time nature 
of electricity markets. In a competitive market, the financial stakes 
of these issues can be huge, thus casting a cloud over operational 
decisions.
    The best working competitive markets, both in the United States 
(ERCOT, PJM) and abroad, have fully separated operational control of 
the transmission system from generation to ensure that there is not 
even a question of preferential access. That increases confidence in a 
truly competitive wholesale market and will encourage the financial 
community to give a second look to merchant generation.
    We are not aware of a specific case in which FERC has actually 
found that a utility has turned away a transmission customer when space 
was available on its lines in order to eliminate competition, although 
there still remains a conflict between the requirement for open access 
and the state requirement to give preference to serving native load in 
order to meet the traditional obligation to serve.
    Question 23. Many energy companies are currently facing severe 
financial difficulties. Some of these companies hurt by bad investments 
are attempting to pass their financial burden onto stable utilities 
that have survived the energy crash. Because of this, many utility 
customers are paying millions more for their utility bills due to the 
energy companies improperly pushing utility affiliates to pay for their 
expenses. As many of you know, I am not a proponent of unnecessary 
regulation. But how else do you propose we fix this problem so that we 
can protect our consumers?
    Answer. Both state regulators and FERC have full authority to 
review all rate-based costs under their jurisdiction and deny recovery 
of any costs that are not prudently incurred. Additionally, state and 
federal regulators have extensive authority to prohibit cross 
subsidization to prevent any attempts by companies to encumber utility 
assets with debt that supports competitive ventures.
    FERC's recent draft order under its Section 204 authority 
concerning utility financings of non-utility ventures is an important 
step in the right direction.
    Most state commissions have done an excellent job protecting 
utility ratepayers from negative impacts of competitive investments by 
utility parents. Regulators have extensive tools to do this, though in 
some cases events of the last two years may provide the impetus to use 
these tools more aggressively.
    Question 24. Standard Market Design (SMD) has been proposed by FERC 
to fix instability in the marketplace. Kentucky has the lowest 
residential electricity rates in the country. Do you believe that 
FERC's proposed SMD rule will work? Will the rule penalize states with 
low costs to benefit those with high costs? Do you believe that the 
proposed SMD rule takes into account unique regional differences and 
individual state interests?
    Answer. The Standard Market Design (SMD) proposed by FERC provides 
an appropriate outline for wholesale electricity markets. At the same 
time, I have encouraged FERC Chairman Wood to take more time to explain 
the SMD to Congress, the states and industry stakeholders, and to show 
as much sensitivity to regional concerns as possible.
    I don't see any reason why SMD should harm Kentucky's consumers or 
consumers in the state of Iowa, where the majority of MidAmerican's 
utility operations are located. Like Kentucky, Iowa is a relatively 
low-cost state in the middle of the country that maintains traditional 
regulated retail electricity service. A robust wholesale electricity 
market with clear market rules and no barriers to investment benefits 
our company and our consumers each time we either have extra power that 
we can sell on the market (profits are split between the company and 
ratepayers) and each time we can buy power on the market at a favorable 
price.
    Though there are many challenging transitional issues to consider, 
it's important to remember that transmission is by far the smallest 
component of a monthly utility bill. Generation costs are more than 
three times the cost of transmission service in the average utility 
bill, and that's where the real savings for consumers lie.
                Questions Submitted By Senator Campbell
    Question 25. As this Committee moves forward on developing a 
comprehensive energy bill and as FERC evaluates its proposed ``Standard 
Market Design'' rule, the effect on consumers must be given the highest 
consideration.
    Answer. I strongly agree that the impacts on consumers of SMD or 
any other legislative or regulatory change should be both Congress' and 
FERC's primary concern.
    Question. Delivering electricity across wide expanses is costly, 
and changes in topography increase those costs dramatically. My state 
of Colorado, which lies on the edge of the Western interconnection 
probably has the most difficult topography in the lower 48 states. Yet, 
Colorado ranks in the top quarter of least expensive states for 
electricity prices in the nation. Denver's electricity prices rank as 
one of the nation's five least expensive.
    26. Why should we seek to change a policy that has worked well for 
states like Colorado?
    Answer. Colorado benefits from having abundant natural resources, 
including plentiful supplies of coal and natural gas relatively near 
the state's population centers. More than any other reason, this is why 
Colorado and Denver electricity prices are low. At the same time, they 
could be lower. The Front Range of Colorado is constrained by 
inadequate transmission capacity to the north, west and south. In 
addition, the state's largest utility is electrically surrounded by a 
federal power-marketing agency, the Western Area Power Administration. 
This results in inefficient and discriminatory use of the existing 
transmission grid by prohibiting the flow of low cost power outside of 
Colorado to the Front Range. FERC's SMD proposal would take baby steps 
to remedy such inefficiencies by making transmission services 
reciprocal and comparable to all users of the grid, on a non-
discriminatory basis. True reciprocity and comparability require 
enabling legislative action.
    It is important to note that there is a significant amount of 
misunderstanding as to what FERC's SMD does for states that maintain 
traditional regulated retail service. Nothing in the SMD would make any 
state change its regulatory scheme from regulated service to retail 
competition. The details of the SMD should continue to be improved 
through the ongoing regulatory process, but I agree with the financial 
analysts who testified at the Committee's hearing, as well as those who 
testified at the FERC technical conference in January, that regional 
differences should be manageable within the SMD framework.
    Question 27. How can we be sure that any policy change would not 
detrimentally impact ratepayers?
    Answer. FERC's SMD proposal contains provisions that assure 
customers can continue receiving the same types of services at prices 
they are used to, if they so choose. Customers have an option to enter 
into long-term contracts that would preserve existing prices and terms 
of service. In addition, existing contracts would be ``grand fathered'' 
or preserved for the remainder of the contract term.
    Nevertheless, there is no way to guarantee that prices in a 
competitive energy market will be lower in the future than they are 
today. There are too many variables, as the recent spike in natural gas 
prices demonstrates, to make an iron clad guarantee of that sort. 
However, if SMD accomplishes its goal and makes it easier, more certain 
and less expensive to move power around the grid, the overwhelming 
majority of consumers, even those in low-cost states, should benefit.
    While some may view the scope of the SMD proposal as broad, the 
fact remains that transmission plays a fundamental role in achieving 
savings in this sector. As the MIT economists Paul Joskow and Richard 
Schmalanzee pointed out 20 years ago in their book, Markets for Power: 
``The practice of ignoring the critical functions played by the 
transmission system in any discussion of deregulation almost certainly 
leads to incorrect conclusions about the optimal structure of an 
electric power supply system.''
    Failure to address competitive issues in the transmission system 
will result in continued high risks for this industry, with concomitant 
low credit ratings, higher costs of capital, and higher rates for 
consumers.
    Question. Central to SMD is the idea that transmission assets will 
be placed in the hands of Independent Transmission Providers (ITPs). 
These ITPs will not have any ownership interest in the assets, but 
rather will be expected to operate them in the ``public interest.'' Can 
you give me examples of when such a system has worked well in the past.
    28. There seems to be general agreement that needed investments in 
our transmission infrastructure are not now being made. But, I can't 
find anything in the SMD proposal that improves the incentives of the 
private sector to make these investments. The proposal seems to 
envision a rather cumbersome planning process involving the ITPs and 
other regulatory entities. Navigating this regulatory labyrinth would 
seem, by itself, to be a disincentive to investment. In your view, does 
the SMD improve the incentives for transmission investment and, if so, 
how does it do it?
    Answer. The not-for-profit ITP is one of two options that the SMD 
provides for operation of transmission assets. The other option, and 
the one MidAmerican prefers, is the independent transmission company, 
or ITC, that is a for-profit business. The independent transmission 
organization MidAmerican will participate in, TRANSLink, includes not 
only investor-owned utilities (such as Colorado's largest utility, Xcel 
Energy), but major public power and rural cooperative systems as well.
    The not-for-profit model works well in both the PJM system and 
ERCOT, but the model that is evolving with or without the SMD is to 
have for-profit transmission companies operating within an umbrella 
regional transmission system.
    As far as the concern that the SMD is a ``regulatory labyrinth,'' 
obviously the proposal is complex, and I hope when FERC gets around to 
issuing a final ruling it can find a way to shave a few hundred pages. 
Any concern about the complexity of the SMD is significantly outweighed 
by the benefits of finally clarifying transmission jurisdiction so that 
we know who will have regulatory authority to ensure that investments 
in necessary transmission expansions and upgrades are made. Unless 
investors know how they will recover the costs of investments in 
interstate transmission, they simply will not invest.
    The system desperately needs harmonization between state and 
federal regulatory authorities. Deputy Secretary McSlarrow put it very 
well in his recent statement before the House Energy and Commerce 
Committee, noting that on transmission we have three choices: 1) turn 
back the clock, which is impossible; 2) remain stuck in transition, 
which is untenable; or 3) complete the transition to competitive, 
regional energy markets for the benefit of consumers.
    With respect to incentives, FERC's SMD proposal, in and of itself, 
does not provide sufficient incentives for transmission and generation 
investment. The proposal acknowledges the important role independent 
transmission companies can play as a result of their single-minded 
focus on a transmission-only business, and it provides for greater 
pricing transparency than now exists by requiring locational marginal 
pricing for congestion management, thus signaling to investors where to 
locate sorely needed infrastructure.
    Legislative action is required to truly spur investment in badly 
needed infrastructure. This would include repeal of PUCHA, 
clarification of FERCs authority over all transmission rates and terms 
of service, and modification of tax policies that penalize compliance 
with Order 888 and 2000 requirements. Interstate electric transmission 
should not be treated differently than interstate natural gas 
pipelines, both in terms of the allowed rate of return on equity and 
depreciation schedules, but it is. In fact, electric transmission 
infrastructure may be a more risky investment than a natural gas 
pipeline when taking into account construction, permitting, siting and 
capital risks.
    Question 29. Some of you are in the wholesale power business where 
the SMD proposal would impose price caps. Won't those price caps 
distort investment incentives in this market?
    Answer. I am philosophically in favor of free markets, and I view 
anything like price caps as an absolute last resort when markets are 
clearly dysfunctional. The price caps envisioned in the SMD are 
reasonable as ``circuit breakers'' to keep markets from spinning out of 
control. I would expect if regional capacity markets are established as 
envisioned in the proposal, the price caps would rarely, if ever, be 
applied.
    Question 30. The SMD proposal doesn't apply to public power, which 
is outside of FERC's jurisdiction. Since large areas would not be 
covered, how can SMD lead to a ``standard'' market design?
    Answer. A robust SMD would bring all owners of significant 
interstate transmission assets under some form of FERC jurisdiction. 
Under existing law, FERC does not have that authority, so it would take 
Congressional action to give it that authority.
    I understand that Senator Thomas' electricity proposal would 
include the ``FERC lite'' compromise that was negotiated in the house 
almost four years ago. I support that, as do virtually all private 
sector energy companies, both utilities and independents. There are 
also public power systems that are voluntarily joining regional 
transmission organizations (RTOs), such as the two large Nebraska 
systems that are our partners in TRANSLink.
    Question 31. The SMD proposal is advertised as promoting 
competition, but isn't it really just a new regulatory regime. 
Moreover, given the complexity of the market that FERC is attempting to 
``design'' isn't it inevitable that there will be serious errors--
errors that will be difficult to correct in a regulatory context?
    Answer. It's accurate to note that the SMD is a new regulatory 
regime, but it is primarily a restructuring of the regulated 
transmission grid to facilitate competition in generation. 
Transmission, by definition, is a monopoly function, and it will always 
be regulated. Those who are trying to claim that in transmission there 
is some philosophical issue between regulation and competition are 
simply being disingenuous.
    On the issue of whether there will be errors made in developing the 
SMD, or even if we didn't move forward with the SMD but simply 
implemented Order 888 requiring all utilities to join regional 
transmission organizations, the answer is yes. Mistakes will certainly 
be made, and we will have to learn from them. It is important to 
remember, however, that California's market design that wreaked so much 
damage on the state and the west, wasn't the result of the SMD or even 
Order 888.
    The issue of mistakes is exactly why I believe Congress should not 
try to legislate a market design. I'd much rather try to fix mistakes 
made through regulation than those that are written into public law.
                Questions Submitted By Senator Cantwell
    Question 32. One of the reasons the Public Utility Holding Company 
Act (PUHCA) was established was because of cozy relations between 
utilities and their affiliate companies. I have read that Berkshire 
Hathaway holds an interest in Fitch rating service, that Fitch has been 
more aggressive than the other rating agencies in down-grading various 
utilities, and that MidAmerican has bought assets--at attractive 
prices--from down-graded utilities. I am not accusing your company of 
unduly influencing the prices of the assets you purchased, but the 
appearance is not favorable. Wouldn't stand-alone PUHCA repeal lead to 
more transactions with similarly questionable appearances, and won't 
this shake investor confidence in the market?
    Answer. Berkshire Hathaway owns no interest in the Fitch rating 
service. It does, however, own an approximate 15% interest in Moody's. 
Berkshire Hathaway has absolutely no influence on Moody's ratings 
determinations. In light of the fact that the rating agencies derive 
their fees from debt issuers, a rating company that were to engage in 
the conduct you suggest would soon lose its client base and be out of 
business. No such allegations have ever been made, and this type of 
innuendo should have no place in this record. These charges are 
unfounded, inappropriate and unwarranted in light of Berkshire 
Hathaway's long record in support of shareholder rights, increased 
corporate disclosure, expensing options, and other corporate and 
accounting reforms that have made it a model for corporate governance 
transparency.
    Question 33. You talked today about the impediments on your company 
making additional investments. I agree that we want to further 
investments in generation and transmission, but my understanding is 
that an exemption already exists for generation investments. So its 
investments in new transmission that might be restricted by PUHCA. 
[Sic.] Why don't we look at a narrow PUHCA amendment addressing the 
transmission issue, rather than repealing the entire statute and its 
other important protections?
    This question raises an important point. PUHCA is, as any 
reasonable person would agree, an impediment to investment in the 
industry at a time when it is desperately needed. If you break down the 
industry into its basic components, you can understand why PUHCA repeal 
will benefit consumers and that concerns about its repeal are 
misplaced.
    Generation is partially free from PUHCA investment restrictions, 
but registered companies are limited in the amount of exempt generation 
they can own, while PUHCA-exempt utility and independent generators are 
not. That is a clear competitive distortion. PUHCA's geographic 
integration requirement prevents geographic diversification of assets, 
and that is counterproductive to all antitrust principles of the past 
century.
    As to transmission and distribution, a transmission company 
exemption would address stand-alone transcos, but PUHCA would continue 
to restrict ownership of transmission assets that are still owned by a 
utility but placed under the operation of an RTO. Another example 
pertains to our interest in expanding our Imperial Valley geothermal 
operations. These plants currently provide the California electricity 
market with approximately 340 megawatts of baseload, emissions-free, 
renewable electricity. We are planning to double the size and output of 
these facilities, providing more renewable electricity to the 
California market. This project will require the construction of 
additional transmission lines, which we considered undertaking, but 
PUHCA's restrictions stood in the way.
    Rather than hearing from MidAmerican on this issue, it might be 
better to consider the arguments of the Oregon Public Utilities 
Commission (OPUC) to the SEC on the issue of whether Enron's single-
state utility exemption for Portland General Electric (PGE) should be 
revoked. OPUC, presumably acting to protect Oregon's ratepayers and to 
seek lower rates, made three key points in its opening and reply 
briefs: First, the state of Oregon, through the OPUC, has adequate 
regulatory authority to protect the regulated utility customers of the 
state without PUHCA:

          The OPUC has adequate authority to regulate [PGE's] utility 
        activities regardless of whether [PGE] trades at the Oregon 
        border or elsewhere. . . . The OPUC effectively regulates these 
        [PGE] activities through the regulatory scheme provided for in 
        Oregon. Although [PGE] enters into some wholesale transactions 
        outside of Oregon, the OPUC has access to the books and records 
        of these transactions. Opening brief, p. 3.

    Second, applying the provisions of the administrative law judge's 
proposed ruling revoking the exemption would effectively punish Oregon 
consumers by causing PGE to limit its wholesale sales to avoid PUHCA 
registration, thus discouraging PGE from: (a) using supply management 
tools that reduce costs to consumers and (b) making off-system sales 
that result in shared savings for PGE and its consumers. ``It benefits 
Oregon ratepayers that Portland General transacts purchases and sales 
of electricity at wholesale in the most cost effective markets 
available in the Western Interconnection, regardless of where such 
markets happen to be located.'' Opening brief, p. 3.
    Third, forcing a utility to sell excess power in-state in order to 
maintain a PUHCA intrastate exemption ``has the potential to result in 
adverse utility behavior.'' As OPUC explained: ``Nearly all utilities 
sell excess power, which often ends up out of the state. Adoption of [a 
strict ``bright line'' test of out-of-state sales] could result in 
utilities deciding to sell excess power within the state, often at 
lower prices.'' Reply brief, p. 3. This test could also hinder the 
ability of utilities needing excess power to purchase that power at the 
most effective location. As OPUC explains, when Portland General has 
the opportunity to purchase cheap hydro power, it can sell excess 
thermal power in the wholesale market and benefit its customers:

          If the [SEC], however, creates a disincentive for [PGE] to 
        sell excess power out of state by subjecting it to [PUHCA], 
        [PGE] may decide not to purchase the less expensive 
        hydroelectric power and, instead, serve its native Oregon load 
        with its higher cost thermal resources. [PUHCA] should not 
        create an incentive for [PGE], or other utilities, to pursue 
        behavior adverse to its retail customer, especially in this 
        situation where the OPUC adequately and effectively protects 
        all of [PGE's] retail customers. Reply brief, p. 3.

    The simple, well understood answer to this investment problem is to 
replace PUHCA and its counterproductive unintended side effects with 
enhanced books and records access so that state and federal regulators 
have complete access to all utility holding companies. That's the basis 
of effective regulation: holding utilities accountable ``by the rate 
base.''
                Questions Submitted By Senator Feinstein
    Question. You have all testified about the poor financial condition 
of energy companies and the challenges they face in the financial 
markets. I believe companies have seen their credit ratings downgraded 
and their stock prices plummet because there is a crisis of confidence 
among consumers and investors.
    34. Do you agree that prudent government oversight to prevent 
against fraudulent and manipulative behavior and more transparency in 
the marketplace will help improve the financial condition in the energy 
sector?
    Answer. As I have stated on several occasions, CFTC oversight of 
energy trading and futures markets is appropriate. Some believe the 
CFTC already has authority in this area, but current law is unclear at 
best.
    Question 35. Currently the energy trading sector is devoid of 
transparency and adequate oversight. I plan to re-introduce legislation 
with Senators Fitzgerald, Lugar, Harkin, Cantwell, Wyden, and Leahy to 
bring oversight to unregulated energy trading and increase penalties 
for misconduct. Do you support the goals of this legislation?
    Answer. I believe it is appropriate and desirable to clarify which 
federal agency has authority over energy trading.
    Question 36. If you have had the opportunity to review the specific 
text of the bill, do you wish to go on record as a supporter?
    Answer. MEHC is reviewing the text of the bill you have introduced. 
We support the intent of the bill and will provide comments in the near 
future.
                              Appendix II

              Additional Material Submitted for the Record

                              ----------                              

               Statement of the Edison Electric Institute
    Mr. Chairman, Members of the Committee, the Edison Electric 
Institute is pleased to submit this statement for the record of the 
Committee's hearing on ``Financial Conditions of the Energy Market.'' 
EEI is the association of U.S. shareholder-owned electric utilities and 
affiliates and associates worldwide.
    In this statement, we will first provide an overview of the current 
financial situation in the electric utility industry. We will then 
briefly describe what Congress can do to help address many of the 
financial challenges facing the industry today.
     the electric utility industry is responding to unprecedented 
                          financial challenges
    The past year has brought some of the most significant financial 
challenges ever experienced by the electricity industry. Shareholder-
owned utilities are feeling the sharp impact of an economic slowdown 
and the aftershocks from the implosion of Enron, and they are 
aggressively taking steps to promote greater transparency in electric 
power markets to rebuild investor confidence.
    They are selling non-core assets, downsizing, issuing new equity, 
canceling acquisitions, reducing significant levels of capital 
expenditures, realigning trading around their own generation assets and 
customer obligations, and accelerating debt repayment. Many are 
adopting a ``back-to-basics'' strategy with its primary focus on their 
core regulated business.
    In addition to individual company actions, EEI, along with Chief 
Risk Officers of utilities, is leading industry efforts to develop best 
practice models in disclosure, risk management, and market oversight. 
Working with Deloitte & Touche, EEI developed a comprehensive study of 
``best practices'' financial information disclosure guidelines that are 
responsive to the Sarbanes-Oxley Act. EEI also has developed guidelines 
for a Model Audit Committee Charter, and a Master Netting Agreement 
designed to enable companies to better manage their risks and improve 
liquidity by netting electric, gas, and financial contracts.
Financial Situation
    For the electric utility industry, one of the most capital-
intensive industries in the world, the erosion of investor confidence 
has a devastating impact on their access to capital on reasonable 
terms. Higher cost of capital makes it more difficult to fund 
infrastructure projects to maintain reliable electric service.
    The shareholder-owned electric utility sector lost $78.3 billion in 
market capitalization between December 2000 and December 2002, a 23.9 
percent drop over two years. This is based upon the stock performance 
of 65 shareholder-owned electric utility companies. If one expands the 
coverage to include unregulated utilities, the drop in market cap is 
even steeper. The EEI Index, a measure of the overall stock performance 
of electric utilities, was down by 14.7 percent in 2002.
Credit Ratings
    Throughout 2002 credit rating changes in the energy sector were 
overwhelmingly negative. According to Standard & Poor's (S&P), the 
ratio of downgrades-to-upgrades rose to 10:1 as of September 2002, up 
from a 3:1 ratio in 1999, 2000, and 2001. Downgrades outnumbered 
upgrades 65 to 20 in 2000. In 2001, that ratio was up to 81 to 29. This 
past year, downgrades outnumbered upgrades by a whopping 182 to 15. S&P 
currently rates 54 percent of energy companies as stable, down from 60 
percent in 2001. The percentage of companies on negative watch has 
risen to 25 percent in 2002. Currently, 18 percent of firms are non-
investment grade, as recently as 2000, this percentage was only 5%. 
``These actions not only have a significant impact on cash flows, but 
also add to the volatility of the sector's stock prices.
    The industry is divided in terms of credit quality. The ratings of 
merchant energy, trading and marketing, and some companies with a 
significant degree of non-core activities have fallen drastically. By 
contrast, most regulated utilities, either vertically integrated or 
transmission and distribution companies, have been affected to a far 
lesser extent. These companies have maintained positive valuations 
through the challenging times and remain in investment grade 
categories.
    As companies are downgraded, they are required to post additional 
cash or other collateral to meet contractual calls. A majority of these 
additional cash requirements are associated with trading operations. 
Ongoing corporate financing needs for any capital improvements--
distribution, transmission or generation--and general operating needs, 
including scheduled debt repayment, will require ready access to 
capital markets at reasonable rates. However, as 2002 progressed, this 
access became more difficult as ratings dropped and fewer lenders were 
willing to extend credit. The result was increased borrowing costs, 
additional collateral requirements, and in some cases, the inability to 
secure the level of borrowing being sought.
Trading
    Companies are closing or reducing trading operations primarily to 
reduce liquidity pressures, related credit rating downgrades and an 
overall decline in trading activities in the industry. Furthermore, 
companies are eliminating trading risks as a means to gain financial 
health, contributing to an overall decline in trading activity. 
Although the future for electricity trading for the shareholder-owned 
electric sector remains uncertain, industry participants agree there 
are strong business reasons to trade around a company's own assets, but 
the business is very complex and those that remain will find a limited 
number of trading counter-parties. The EEI Master Netting Agreement 
also will help mitigate some of the risk around trading and improve 
liquidity in the marketplace.
Generation Plants
    Due to the current state of the markets and the economy, many 
companies are curtailing capital spending by deferring construction 
plans or canceling plants. The sector's cash crunch, increased cost of 
capital, credit pressures and extremely low power prices all 
contributed to the decline in construction activity.
    Cancellations of power projects and delayed projects increased in 
the last half of 2002 and into 2003, as the cost of capital and 
refinancing escalated. According to Platts, a total of 475,085.9 MW is 
scheduled to come on line between 2002 and 2007. Cancellations or 
delayed announcements reached 33.8 percent or 160,491.5 MW by the close 
of 2002.
    Despite the ongoing cut backs in construction plans, because so 
many projects are already in the pipeline, analysts believe new plant 
additions for 2003 will continue to outpace electric demand growth, 
which is lagging in the sluggish economy. This trend is expected to 
continue through at least the end of this year. Reserve margins are 
vastly higher than prior years in most regions of the country. With 
economic recovery, however, will come the need for more generation to 
meet a resurgence in demand growth.
Debt Restructuring
    It is estimated that the power industry will require $100 billion 
in refinancing of short and long-term loans during 2003. The potential 
for new financing is affected by the drop in project value as power 
prices collapsed and cash flows declined significantly. Additional 
refinancing needs are stemming from bridge loans for acquisition 
activity over the past decade and general corporate credit facilities 
that are scheduled to expire shortly. Increasingly, companies are 
required to pledge assets to secure new financing arrangements, 
reducing financial flexibility. Companies are striving to improve cash 
flow by executing asset sales, controlling costs, and minimizing 
collateral calls.
                          what congress can do
    The electric utility industry is taking significant steps to 
restore investor confidence among investors and on Wall Street, and EEI 
is leading an aggressive action plan for the electric industry that 
embraces vastly greater transparency and best practices models in 
disclosure, accounting, and market oversight.
    Congress also can play an important role, including the adoption of 
a comprehensive national energy policy that provides the right 
incentives to grow the electricity system and sets a clear direction 
for the future.
Promote Investment and Market Liquidity
    Competition in U.S. wholesale electricity markets lowers consumers' 
electricity bills by nearly $13 billion annually, according to the U.S. 
Department of Energy. However, it also has brought major changes in the 
use of, and explosive growth in the number of transactions on, the 
nation's transmission systems. As a result, transmission systems are 
facing dramatic increases in congestion, which threatens reliability, 
makes it more difficult for new entrants to sell power in the market, 
and increases costs to consumers. According to data from the North 
American Electric Reliability Council (NERC), executed transaction 
volume has increased 400% in the last four years, as measured by 
requests for ``transmission loading relief.''
    For the past 25 years, however, investments in transmission have 
actually been declining an average of $81 million per year compared to 
the investment needed to maintain the current level of adequacy. 
Interminable delays in getting siting approvals and permits necessary 
to build facilities on public lands are just some of the obstacles that 
contribute to uncertainty and make it more difficult to attract 
investment in transmission projects.
    Meanwhile, the Federal Energy Regulatory Commission (FERC) is 
moving forward aggressively with its transmission policies. In response 
to FERC Order 888, shareholder-owned utilities are providing open, 
nondiscriminatory access to their transmission systems. Under FERC 
Order 2000, they are forming Regional Transmission Organizations 
(RTOs), which will develop, operate and maintain regional wholesale 
markets and infrastructure on a day-to-day basis. FERC is also seeking 
to develop a standardized market design for wholesale markets. It is 
critical that this design reflect the market differences in various 
regions of the country, and provide the right market signals to 
facilitate transmission upgrades and expansions. We are working with 
FERC and state regulators to that end.
    Congress can help to ensure the development of a robust electricity 
market by taking steps aimed at removing barriers and supporting 
incentives to enhance transmission infrastructure and other investments 
necessary to support competitive, regional electricity markets:

   Repeal the Public Utility Holding Company (PUHCA) and 
        transfer consumer protections to FERC and the states. PUHCA is 
        an outdated statute that stifles investment and poses a barrier 
        to competition. PUHCA repeal has been part of every major 
        electricity bill and has long been recommended by the SEC and 
        other federal agencies. With the current investment crisis 
        faced by the industry, PUHCA repeal is more important now than 
        ever.
   Grant FERC backstop authority to help site new transmission 
        facilities that would relieve national interest transmission 
        bottlenecks identified by DOE if a state fails to act on an 
        application within a year or materially alters the transmission 
        plan. As wholesale markets become more regional in scope, new 
        transmission lines are needed to move power across and between 
        regions. It has become increasingly difficult to obtain siting 
        approvals from authorities in states and localities across 
        which these regional lines must cross, which makes it harder to 
        attract the massive investment needed for major transmission 
        projects. FERC backstop transmission siting authority would be 
        similar to its longstanding authority to site natural gas 
        pipelines. It would be used only as a last resort.
   Provide for the coordination of transmission siting 
        activities among multiple federal land management agencies by 
        designating a lead agency and streamlining the permit process. 
        This legislation is especially important in western states, 
        where the predominance of federal land ownership creates a 
        situation where lack of coordination among agencies, or even a 
        single uncooperative federal land management employee, can hold 
        up a badly needed transmission project for months or longer.
   Require FERC to issue a rule providing for innovative 
        pricing policies for RTOs or a transmitting utility whose 
        facilities are controlled by an RTO. FERC has indicated a 
        willingness to take some steps in this direction, but Congress 
        can ensure that additional measures are taken to attract the 
        capital to fund needed investments in transmission.
   Eliminate transmission divestiture tax barriers to the 
        formation of independent regional transmission entities. 
        Federal tax laws impede the divestiture of transmission assets 
        to RTOs or independent transmission companies (ITCs) by 
        imposing a tax cost on any transfer of transmission from an 
        electric utility to an RTO or ITC, which has the effect of 
        discouraging new investment and the construction of new 
        facilities. DOE and FERC have expressed support for concepts 
        embodied in the House and Senate energy bills in the 107th 
        Congress that would have addressed this problem.
   Reduce the depreciable lives of transmission assets from 
        their current 20-year recovery period to a period more 
        consistent with other capital-intensive industries. Speeding up 
        the depreciation period for transmission assets will reduce the 
        required rate of return for new investment because it lowers 
        the cost of capital. It will also increase cash flow, thereby 
        providing additional resources for utilities to invest in 
        modernizing and increasing the capacity of their transmission 
        systems.
   Eliminate the double taxation of corporate dividends. Under 
        current tax law, corporate dividends are taxed twice--first at 
        the corporate level and then again at the individual 
        shareholder level. The double taxation of corporate dividends 
        is fundamentally unfair and is bad tax policy. Congress is now 
        considering a proposal to eliminate the double taxation of 
        corporate dividends. This proposal is extremely important to 
        America's electric companies, which have a long history of 
        paying dividends to their shareholders, and to the millions of 
        people who own shares in these companies.
   Extend and expand the amortization of pollution control 
        equipment. Five-year amortization of pollution control 
        equipment at all generating plants--older plants (pre-1976 
        vintage) as well as new plants--would promote modernization or 
        construction of new pollution control facilities. Congress 
        should: (1) extend the current law's five-year amortization for 
        pollution control equipment to all older plants and (2) modify 
        current law to make it applicable to all power plants.
   Amend the bankruptcy code to protect the value of cross-
        commodity netting. Over the past year, EEI developed a Master 
        Netting Agreement designed to enable companies to better manage 
        their risks and improve liquidity by netting electric, gas, and 
        financial contracts. These in turn help promote a liquid, well-
        functioning marketplace. In 2002, provisions were agreed upon 
        in the bankruptcy reform bill that would have addressed netting 
        concerns, but the bill died in conference due to unrelated 
        concerns.
   Update the tax treatment of nuclear decommissioning costs. 
        All owners of nuclear power plants make contributions to 
        external trust funds to ensure that monies are available to 
        decommission the plants when they are taken out of service. 
        Federal tax law allows owners to deduct from taxes the amounts 
        contributed to these funds, but the law was designed to operate 
        within the structure of a fully regulated electric industry. 
        The U.S. Tax Code should be updated to assure that companies 
        can deduct decommissioning funds in a deregulated generation 
        market, and to ensure that the transfer of nuclear plants to 
        new owners can occur, and without penalty. Provisions to 
        accomplish these two goals were approved by both the House and 
        Senate as part of the energy bill during the 107th Congress.
   Reform FERC's merger process by streamlining the process and 
        setting deadlines for decisions regarding electric utility 
        mergers. Utility mergers are among the most heavily scrutinized 
        of any industry, due to a complicated and duplicative 
        regulatory review process by multiple federal and state 
        agencies that often results in costly delays that can sometimes 
        drag on for years.
Promote Wholesale Competition
    Congress can help promote the growth and efficient operation of 
robust wholesale electricity markets by taking steps to close gaps in 
federal regulation of wholesale markets and other measures.
    Approximately 30 percent of the transmission system is owned by 
government-owned utilities and cooperatives not subject to FERC 
authority. As a result, FERC's open access rules and the market 
structures being designed to make wholesale markets operate more 
efficiently and fairly do not apply to these nonjurisdictional 
entities. This bifurcated regulatory regime creates the potential for 
gaps in the system, which means additional uncertainty.
    Jurisdictional gaps in federal regulation of wholesale electricity 
markets allow some market participants to exploit flaws or loopholes in 
the system, which undermines the overall strength of the market. 
Congress should ensure that FERC has the same level of authority to 
address market power concerns relating to actions by non-jurisdictional 
utilities as it has over shareholder-owned utilities:

   Grant FERC authority to require non-jurisdictional utilities 
        that own transmission to provide nondiscriminatory open access 
        to their transmission facilities at rates comparable to those 
        that they charge themselves and on terms and conditions 
        comparable to those shareholder-owned utilities are required to 
        offer. FERC lacks jurisdiction over about 30 percent of the 
        transmission lines nationwide; in some areas of the country, 
        particularly the Northwest, a vast majority of transmission 
        lines are owned by nonjurisdictional utilities such as 
        government-owned utilities and electric cooperatives. According 
        to December 2002 GAO report, ``Lessons Learned From Electricity 
        Restructuring,''

                  ``As a result of the lack of jurisdiction across wide 
                regions of the country and over significant 
                transmission lines connecting some areas of the 
                country, FERC has not been able to prescribe the same 
                standards of open access to the transmission system. 
                This situation, by limiting the degree to which market 
                participants can make electricity transactions across 
                these jurisdictions, will limit the ability of 
                restructuring efforts to achieve a truly national 
                competitive electricity system and, ultimately, will 
                reduce the potential benefits expected from 
                restructuring.''

   Establish a self-regulating reliability organization, with 
        FERC oversight, to develop and enforce reliability rules and 
        standards that are binding on all market participants. With the 
        growth of competition, the traditional system of voluntary 
        reliability standards is no longer workable. Congress should 
        enact consensus reliability language agreed upon by 
        stakeholders in 2002, which also accommodates special regional 
        issues.
   Clarify the ability of federal utilities to loin RTOs. There 
        is some legal uncertainty as to whether federal utilities can 
        join Regional Transmission Organizations (RTOs), a cornerstone 
        of regional wholesale market structure. In some regions, 
        especially the West, where federal utilities own a majority of 
        the transmission system, RTOs simply cannot work without 
        federal utility participation.
   Reform the Public Utility Regulatory Policies Act (PURPA) by 
        repealing the mandatory purchase obligation protecting existing 
        contracts and providing for the recovery of federally mandated 
        FERC-jurisdictional PURPA costs. PURPA costs electricity 
        consumers nearly $8 billion annually in excess power costs, and 
        it has outlived its usefulness with the development of open 
        access to wholesale markets. PURPA reform is another item that 
        has been part of every major electricity bill considered by 
        Congress.
   Grant FERC authority to order refunds from non-
        jurisdictional utilities if it determines that the prices 
        charged by those utilities are unjust and unreasonable. 
        Consumers of shareholder-owned utilities should be able to 
        receive refunds if FERC determines that the wholesale power 
        prices charged by government-owned utilities and cooperatives 
        are unjust and unreasonable. One of the most important lessons 
        learned from the California energy debacle is that FERC's 
        refund authority should cover all market participants, 
        regardless of ownership structure.
   Expand FERC's investigative authority and information 
        reporting requirements to all entities that participate in 
        wholesale electricity markets. For, wholesale markets to work 
        properly, there can be no distinction among different types of 
        suppliers when it comes to market transparency.

    In summary, the nation's electric system is a key part of our 
critical infrastructure. It is also one of the most capital-intensive 
industries in the world. The electric utility sector is facing some of 
its most significant financial challenges ever. Electric companies are 
taking the necessary steps to restore investor confidence in the 
industry. However, we also encourage your support for the measures we 
have outlined to help restore capital investment in our critical 
electricity infrastructure and promote the smooth and even operation of 
wholesale electricity markets to the benefit of consumers and the 
economy.
                                 ______
                                 
           Statement of the American Public Power Association

    The American Public Power Association (APPA) is pleased to submit 
testimony to the Committee for its hearing on the financial conditions 
of today's energy markets. APPA represents the interests of more than 
2,000 publicly owned electric utility systems across the country, 
serving approximately 40 million citizens. APPA member utilities 
include state public power agencies and municipal electric utilities 
that serve some of the nation's largest cities. However, the vast 
majority of these publicly owned electric utilities serve small and 
medium-sized communities in 49 states, all but Hawaii. In fact, 75 
percent of our members are located in cities with populations of 10,000 
people or less. Further, most publicly owned utilities are not 
generation self-sufficient but depend on wholesale power purchases to 
meet the retail loads of the communities they serve.
    The failure of electric utility industry deregulation in California 
has had and continues to have broad and far-reaching adverse effects 
throughout the West. Electric utilities and their consumers in Western 
states have experienced unprecedented volatility of electric prices. 
Discoveries of market manipulation and abuse by energy traders and 
private utilities have sent a shockwave through the industry that has 
forced several energy companies to file for bankruptcy and prompted 
credit downgrades of investor-owned utilities. The large drop in the 
stock prices and credit ratings of energy companies further 
demonstrates evidence of the electricity industry's poor financial 
state. Conversely, during this crisis public power has continued to 
receive strong credit ratings. Citing sound management strategies, 
credit rating agencies have projected a positive outlook for public 
power and as a result public power is well positioned to continue to 
provide the low-cost, reliable service that has been our trademark.
    Throughout the second half of the 1990s investors bought energy 
company stocks based on large reported profits and strong balance 
sheets. The stock price of Enron, formerly one of the nation's largest 
energy traders, reached all time highs of $90 in the summer of 2000 as 
Enron and other energy traders benefited from the introduction of 
electricity deregulation in California. As a result of deregulation the 
average price of a megawatt of electricity, which was approximately $30 
before deregulation, spiked to as high as $10,000. Some investor-owned 
utilities created affiliate energy trading companies as a means to 
capitalize on deregulation. While these and other energy trading 
companies were pulling in record profits, consumers in the West were 
suffering rate increases and power outages that will ultimately cost 
billions of dollars.
    In 2002, the so-called Enron ``smoking gun memos'' that identified 
manipulative trading practices utilized by Enron traders to drive up 
the price of electricity were uncovered. In addition, it was discovered 
that Enron had overstated it's earnings while at the same time hiding 
debt from the public. It was soon revealed that other companies had 
engaged in similar market manipulation schemes intended to increase 
electricity prices at the expense of consumers. As more and more 
questionable trading practices by companies were uncovered Wall Street 
investors responded with an understandable anxiety that crippled the 
stock values of these companies. Many investor-owned utilities are now 
suffering the negative effects of their diversification efforts and the 
volatility in earnings generated from their trading operations that 
were spawned by deregulation.
    Unlike regulators, the markets have not been slow to punish 
corporate corruption. Enron is in bankruptcy-court proceedings and the 
stock price of Dynegy, another large trader, which in May 2001 had been 
traded at a high of $57, is now being traded at approximately $2. Other 
energy trading companies, such as the Williams Companies and El Paso 
Corp., have also suffered dramatic decreases in the value of their 
stock. Even Duke Energy, consistently rated among the top IOUs, had its 
credit rating reduced and its rating outlook revised to negative. In 
2002, 182 investor-owned utilities received credit downgrades from 
Standard & Poor's. The weakened financial condition of energy companies 
clearly hurts both investors, who have lost billions of dollars, and 
consumers, who will pay higher rates as the result of utility 
companies' lower credit ratings and higher cost of debt.
    Public power has not been unaffected by the Western energy crisis. 
For example, public power systems that comprise the Northern California 
Power Agency voluntarily participated in the state's ISO load 
curtailment program and as a result were subject to blackouts, even 
though they had sufficient resources to meet their own loads. In 
addition, public power systems in the northwest had to increase their 
electricity rates to procure long-term power to get through the energy 
crisis.
    However, in contrast to energy trading companies and investor-owned 
utilities the credit ratings of public power systems have remained 
stable. During 2002, out of 197 public power entities evaluated by 
Standard & Poor's, there were only 14 downgrades. Furthermore, these 
downgrades were balanced by 12 upgrades during the same period. More 
than 80% of the total public power entities rated by Standard & Poor's 
are rated A- and higher. In its' ``Outlook 2003: U.S. Power and Gas'', 
Fitch Ratings states ``Public: power was by far the most stable utility 
sector in 2002, and the outlook remains clear for the coming year.'' 
Standard and Poor's and Moody's Investors Service also project a strong 
outlook for public power in 2003.
    Credit rating agencies cite several reasons why public power has 
been able to weather the Western energy crisis and maintain a stable 
outlook. The previously mentioned Fitch Ratings report ``Outlook 2003: 
U.S. Power and Gas'' states as an explanation of public power's 
success:

          ``Part of public power's success reflects a conscious 
        decision by utility managers and board of directors to avoid 
        the riskiest parts of electric deregulation, such as wholesale 
        power marketing and merchant transactions. By nature public 
        power agencies tend to be a more conservative group. They view 
        their primary mission as serving native load customers on a 
        mostly not-for-profit basis.''

    Public power's first and only purpose is to provide reliable, 
efficient electric service to its citizens. Unlike private power 
companies, public power systems do not have to serve stockholders as 
well as customers. Public power's measure of success is how much money 
they can keep within their communities through low rates and reliable 
service, not how much can be taken out to send to distant stockholders 
who are not part of the community.
    As California is learning, electric prices drive local economies. 
For years, public power has had a proven track record of providing 
customers with lower-cost electric rates than private power companies 
on a national average. For instance, residential rates for public power 
systems are nearly 17% lower than for private companies, while 
commercial rates are approximately 10% lower for public power. Several 
factors help explain this, one of the primary ones being local control, 
where public power systems are regulated by local, citizen-controlled 
boards.
    In a report entitled ``Stability Expected in the U.S. Public Power 
Sector Despite Increasing Risk and Market Volatility'', Standard & 
Poor's states that ``Public power should be recognized for having 
demonstrated the ability to adapt to the heightened risk and to 
continue to meet native load demands while maintaining the financial 
health and operational consistency that has led to stabile credit 
quality.'' The report further states, ``Public power entities 
nationwide continue to adapt both operationally and financially to new 
challenges.''
    One example of a public power entity successfully adapting during 
the Western energy crisis to provide affordable electricity to their 
customers while maintaining financial integrity can be seen in the 
actions of Tacoma Power. Faced with significant costs related to 
wholesale power purchases, Tacoma Power was able to quickly act on a 
plan to maintain financial stability. The six-point plan included a 
surcharge on rates, borrowing, conservation, cost cutting, new 
generation, and legislative and regulatory action. The rapid 
development and implementation of this plan insured that the utility's 
financial condition was maintained and system reliability was assured.
    Public power utilities make good business decisions each and every 
day, as demonstrated by their lower rates, reliable service and solid 
credit ratings from Wall Street. Many of these decisions are made 
through local democratic processes that prevent the committing of major 
errors that threaten the future of a business and its customers. 
Political pressure on public power officials, when it occurs, is 
pressure to provide consumers with low-cost and reliable electric 
service, not greater profits to stockholders.
    In a report entitled ``As Electric Industry Restructuring 
Continues, Municipal Electric Utility Risk Management remains a Major 
Challenge'', Moody's Investors Service states that ``utility management 
strategies to position for a more competitive workplace, including 
improving financial liquidity and risk management'' has been a major 
factor in maintaining credit stability. For example, the Sacramento 
Municipal Utility District (SMUD) has implemented a financial plan over 
the past several years to position the utility for competitive retail 
markets. When natural gas prices rose and SMUD had to purchase power to 
replace lower hydroelectric production, SMUD had the liquidity to 
manage for a period of time. SMUD was able to devise a rate 
restructuring that established a rate surcharge to maintain its sound 
financial position and to replenish a rate stabilization fund to be 
available for future market disruptions.
    Because of their solid management and commitment to the core value 
of serving all their customers, public power utilities were able to 
survive the turmoil of the Western energy crisis. While some Western 
public power utilities were hurt by the skyrocketing wholesale power 
prices during the energy crisis, they were able to minimize the effect 
on their consumers and remain fiscally responsible because of their 
flexibility and local control. The overall performance of publicly 
owned utilities has clearly shown that the traditional concept of not-
for-profit operation subject to local control works. As the Committee 
considers measures to restore the financial condition of energy markets 
APPA urges opposition to any efforts that would impair the principle of 
local control that has allowed public power to serve its members for 
over 100 years. Further, it is critical that Congress understand the 
lessons of the Western energy crisis before proceeding with changes 
affecting the $200 billion wholesale electric utility market. Enacting 
electricity legislation without full understanding of the Western 
energy crisis will almost surely result in unintended adverse 
consequences that will cause further harm to energy markets as well as 
consumers.
                                 ______
                                 
 Statement of Kara M. Silva, Vice President, MBIA Insurance Corporation

    Thank you, Mr. Chairman and members of the Committee for the 
opportunity to provide testimony regarding the financial condition of 
the electricity markets. MBIA believes that regulators and the U.S. 
Congress can play an important role in helping to address the current 
state of the electricity markets. Much can be done to help ensure that 
utilities are financially healthy, so that the markets, investors, and 
consumers will not be further harmed.
    In my testimony, I will describe provisions of current law that may 
serve as important safeguards for maintaining the financial health of 
utilities. I will explain why it is vital these provisions not be 
repealed, but rather strengthened. Finally, I will make recommendations 
for legislative changes to guard against the further weakening of 
utilities' financial position.

                          DESCRIPTION OF MBIA

    I am Kara Silva, a Vice President of MBIA Insurance Corporation. 
Because MBIA tracks the performance of utilities so closely, we are 
often among the first to see problems within this sector. MBIA 
approaches the critical issues facing the electricity industry from its 
perspective as an insurer of the bonds of many domestic electric 
investor owned utility companies (``IOU''), and as a representative of 
bondholders' interests. The financial distress and increased risks 
facing the industry are serious problems that must be addressed.
    MBIA is the premier financial guaranty insurance company in the 
world. We are a Triple-A rated monoline financial guaranty insurance 
company regulated primarily by the New York State Insurance Department. 
As opposed to multiline insurance companies, monoline financial 
guaranty insurance companies engage in only one line of insurance--
financial guaranty insurance. Our Triple-A ratings from Moody's 
Investors Service, Standard & Poors and Fitch enable us to offer 
qualified issuers the ability to borrow money in the public markets at 
the lowest possible interest rate. Once these debt obligations are 
sold, MBIA guarantees--unconditionally and irrevocably the timely 
payment of principal and interest to bondholders. We effectively step 
into the shoes of the bondholders and represent their interests in the 
capital markets.
    I am responsible for managing MBIA's global utility portfolio which 
consists of over 1,300 issuers worldwide and which has a total par 
value of over $63 billion. My primary responsibilities include 
monitoring this portfolio to identify and mitigate credit decline of 
financially troubled obligors.
 profound changes in iou sector: financial distress and increased risks
    The domestic electric investor-owned utility sector has undergone 
profound changes in recent years. Many IOUs are experiencing financial 
distress because of aggressive expansion sanctioned by recent 
deregulation. The regulatory safety net has not performed as expected. 
And the electric IOU sector has experienced several shocks due to ill-
conceived restructuring plans and instances of corporate malfeasance.
    As a result, the risk profile of the electric IOU sector has 
changed significantly. What formerly were ``safe'' utility credits are 
now performing like corporate credits in other sectors. In order to 
understand the effects of this change on the ability of IOUs to access 
the capital markets, it is important to focus on the legislative, 
corporate, regulatory, business and financial risk points. In each of 
these areas, exposure to risk has been heightened.
    From a legislative standpoint, the sector faces risk as states 
enact inconsistent legislation and utility customers that are most at 
risk have open access to choose alternative providers. The ability to 
recover stranded costs and the sale of generating assets all increase 
risk exposure as restructuring occurs.
    On the corporate side, we carefully monitor mergers and 
acquisitions--particularly as utilities expand into deregulated or 
international lines of business. We have seen an unusually high number 
of distressed parent companies, as well as heavy litigation and 
governmental investigations into corporate activities.
    Regulatory risk at the state level comes from rate caps combined 
with the inability to pass through costs, as well as from differences 
in state regulatory decision-making. On the federal level, regulatory 
risk comes from the possible repeal of the Public Utility Holding 
Company Act of 1935 (``PUHCA'') and the potential elimination of the 
Federal Energy Regulatory Commission's (``FERC'') merger authority.
    Finally, the sector faces business risks from capacity issues, a 
core business highly impacted by weather and the economy, and a high 
cost structure with impending competition--not to mention fuel supply 
and environmental costs.
    These factors combine to create significant financial risk in this 
sector. Poor non-utility investment decisions have led to weak balance 
sheets. Weak balance sheets have led to liquidity problems and 
downgrades by the rating agencies. Downgrades have led to collateral 
calls and other rating-related triggers that accelerate the liquidity 
problem. Furthermore, overbuilt capacity reduces the value in planned 
asset sales meant to reduce debt and improve liquidity.
    Weak balance sheets, poor liquidity and uncertainty of 
restructuring plans have made access to the capital markets very 
difficult and very expensive. An overall theme has emerged from the 
current market dynamics: it is difficult to have regulated and non-
regulated activities in the same corporate family. Regulators are 
having to adapt their current authorities to the emerging challenges 
presented by the co-existence of utility and non-utility affiliates, 
and it is unclear at this point whether those authorities will be 
sufficient in all instances. Moreover, some utilities do not want to 
diversify into non-regulated business.

             ROLE OF REGULATORS: REGULATORY ``CHECKPOINTS''

    MBIA has urged state commissions and other regulators to exercise 
their full authority toward fashioning realistic solutions. The most 
difficult dilemma for regulators is the jurisdictional context in which 
agencies must operate to protect consumers. Jurisdiction over corporate 
structure, finance, and governance is shared by the FERC, Securities 
Exchange Commission (``SEC''), and state regulatory commissions--and 
the jurisdictional split is not easily discernible. A single corporate 
transaction might require authorizations from more than one agency.
    When a utility is financially troubled, there are several 
regulatory ``checkpoints'' that can serve as warning signals to 
regulators and to the public that regulatory intervention might be 
warranted. These checkpoints include regulatory proceedings at FERC, 
the SEC, and before state commissions. Regulators have the opportunity 
at these checkpoints to assure that the proposed action by the 
utility's corporate family will not harm the utility's financial 
position.
    However, while state and federal regulators have the ability to 
address many problems when utilities are financially troubled, their 
abilities sometimes stop short of what is needed to reach all trouble 
spots. Jurisdictional limits and uncertainty regarding jurisdiction can 
in some instances be a barrier to needed regulatory action. MBIA 
believes that Congress should step in to close regulatory gaps and add 
certainty to regulatory jurisdiction, to help ensure that the financial 
health of regulated utilities is restored and maintained. MBIA would 
urge the Committee to strengthen, rather than weaken, the regulatory 
review performed at these checkpoints.
FERC
    At least two of the regulatory checkpoints are at FERC--electric 
utility applications filed under Sections 203 and 204 of the Federal 
Power Act.
            Section 203
    Section 203 requires FERC's approval of any sales or other 
dispositions of FERC-jurisdictional facilities that exceed $50,000 in 
value.\1\ This includes mergers and acquisitions, certain divestitures, 
and corporate reorganizations. Given that many parent energy companies 
are seeking to shore up their balance sheets and those of their non-
regulated subsidiaries, and utilities are merging with more risky non-
utility counterparts, such as power marketers, these kinds of 
transactions warrant careful monitoring.
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    \1\ 16 U.S.C. Sec. 824b.
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    At the moment, many parent companies may be looking to the 
regulated utility to help improve balance sheets, and questions arise 
whether Section 203 transactions will always be in the best interest of 
the regulated utility. At this checkpoint, FERC may wish to consider 
whether the Section 203 transaction helps, hurts or is neutral to the 
utility. Intervenors, such as state commissions and other stakeholders, 
may also add to FERC's deliberations.
    For example, in the case of a sale of jurisdictional assets, it is 
appropriate for FERC to question, as it has in a recent letter to an 
energy company, how the proceeds of an asset sale will be allocated 
within the corporate family, and whether the regulated utility will be 
left holding indebtedness related to the asset that has been sold.\2\ 
Such scrutiny insures that the utility subsidiary does not become laden 
with debt unrelated to its own assets and activities.
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    \2\ El Paso Corp., Docket Nos. FA02-36-000 and IN02-6-000, Letter 
Order (unpublished) issued Feb. 26, 2003.
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    Another example is the acquisition of a utility by a non-utility 
corporation, such as a diversified company or power marketer. MBIA 
believes that FERC can, and should, review such acquisitions to ensure 
that the credit and financial strength of the utility is not weakened 
by its induction into a corporate family of more risky businesses. If 
FERC were to require as a condition to such a merger the establishment 
of appropriate corporate and financial separations--so-called 
``ringfencing''--utility investors and consumers would be safeguarded 
from harm.
    Broadly speaking, ringfencing is simply an effort to wall off 
certain assets or liabilities within a corporation. For example, this 
can be done by creating a new subsidiary, or by limiting or prohibiting 
internal financing to an existing subsidiary. Ringfencing has been a 
common practice among businesses with large liability exposures, such 
as tobacco companies, to protect less risky affiliates. But MBIA 
believes that thoughtfully applied ringfencing techniques can be 
effective tools for regulators to protect the public interest by 
shielding core utility assets from affiliated non-utility businesses.
    Standard & Poor's views the Oregon Public Utilities Commission 
(``OPUC'') as being among the most supportive of utility credit quality 
in the country--in large part because of the restrictive ringfencing 
conditions imposed on Enron when it acquired Portland General Electric 
Company (``PGE'') in 1997. In its decision-making process, the OPUC 
specifically considered the effect of the acquisition on PGE's 
financial structure and utility assets.
    Among the OPUC's conditions were the maintenance of a 48 percent 
equity level at PGE and advance notification of special or large 
dividends to Enron. In addition, PGE was required to maintain a 
separate accounting system. As a result of these and other conditions, 
PGE was one of only a handful of Enron assets to emerge intact after 
Enron's bankruptcy. While PGE's future is still uncertain, its 
corporate credit rating is significantly higher than would be expected 
as a result of the ring-fencing criteria.
    Under the Federal Power Act, FERC cannot approve proposed Section 
203 transactions unless they are ``consistent with the public 
interest.'' In making this determination, FERC currently considers 
three factors: the effect of the proposal on rates, the effect on 
competition, and the effect on regulation. We believe it to be in the 
public interest, and consistent with the three factor test, for FERC to 
consider the effect on the health of the regulated utility, and to 
require ringfencing as a condition to mergers in which utility and non-
utility businesses are mingled.
    The current state of the electricity industry makes it critical for 
FERC to have clear, strong authority to review mergers and other 
dispositions of facilities so that IOUs, and their ratepayers and 
shareholders are not harmed. FERC has the expertise and experience 
necessary for the job. And as the number of mergers, corporate 
reorganizations, and divestitures increases in the current financial 
climate, FERC must have clear authority to do so. MBIA recommends that 
Congress enact legislation that would clarify FERC's authority to 
protect the financial health of the regulated utility, in the context 
of Section 203 transactions. And in contrast, the repeal of Section 203 
as has been advocated by some would remove a significant tool to 
protect utility financial strength.
            Section 204
    Applications filed under Section 204 of the Federal Power Act also 
serve as a regulatory checkpoint at FERC, where regulated utilities 
must obtain FERC's approval for debt and equity offerings.\3\ FERC, in 
its recent Westar Energy, Inc. order, has revised its criteria for 
approval of Section 204 applications.\4\ FERC's new policy attaches 
certain restrictions on all public utility issuances of secured and 
unsecured debt authorized by FERC. MBIA commends FERC on its action in 
this important case, because these conditions are aimed at protecting 
utilities from the cost and risk of non-utility debt. The Westar 
conditions will provide important safeguards at least for those 
issuances that come before FERC for approval.
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    \3\ 16 U.S.C. Sec. 824c.
    \4\ Slip op., Docket No. ES02-51-000 (issued Feb. 21, 2003) 
(``Westar'').
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    However, not all debt and equity issuances are subject to FERC 
review. In the case of registered holding companies, the SEC is the 
agency with such authority. And, to the extent a state regulator 
reviews issuances, no application before FERC is necessary. Thus, 
Section 204 is at present not a complete safety net for issuances that 
pose risks to utility financial strength.\5\
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    \5\ The Kansas Corporation Commission (``KCC'') also has been 
proactive in scrutinizing corporate applications with a view toward 
shielding utility investments from poorly performing non-utility 
ventures. The KCC recently used its authority over corporate governance 
and debt management to require an application to transfer its utility 
division to a utility-only subsidiary, and ordered institutional 
safeguards to separate the utility and non-utility businesses. This 
decision preceded, and complemented, the FERC's decision on Westar's 
application to issue securities, and effectively prevented the utility 
from assuming non-utility debt.
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SEC
    In addition to FERC, the SEC is another federal venue that provides 
regulatory checkpoints for troubled utilities. The proposals of multi-
state utility holding companies, or holding companies that are 
registered under PUHCA, must often be reviewed by the SEC, under 
PUHCA's requirements. Utility holding companies that are exempt from 
PUHCA's registration requirements are subject to much less regulation. 
One of the areas within the SEC's jurisdiction is review of registered 
holding companies' proposed investment in non-core, non-utility 
businesses. Poor non-utility investment decisions have led to weak 
balance sheets in the industry. While registered company acquisitions 
of some non-utility businesses are exempt from the SEC's review, such 
as acquisitions of exempt wholesale generators and foreign utility 
companies, the associated financing of such diversified investment must 
usually be approved by the SEC.
    Financing in the form of the issuance and sale of securities for 
non-utility investment is subject to SEC approval under Sections 6 and 
7 of PUHCA.\6\ Under PUHCA, the SEC must not allow a proposed financing 
of non-utility investment if the terms of the financing are 
``detrimental to the public interest or the interest of investors or 
consumers.'' Consideration of the potential impact on the regulated 
utilities in a holding company system should fall squarely within this 
inquiry. Intervenors, such as state commissions and other stakeholders, 
can add to the SEC's deliberations.
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    \6\ 15 U.S.C. Sec. Sec. 79f and 79g.
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    Proposed registered holding company acquisitions of non-utility 
businesses, that are not subject to any special exemption from SEC 
review, must be reviewed under Sections 9 and 10 of PUHCA.\7\ Together, 
Sections 9 and 10 require that acquisitions of interests in 
businesses--not just utility businesses--must not be ``detrimental to 
the public interest or the interest of investors or consumers or the 
proper functioning of the holding company.'' Here again, the impact of 
proposed non-utility investment on the system's regulated utilities can 
be considered. State commissioners and others can file comments on 
these proposals, as well.
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    \7\ 15 U.S.C. Sec. Sec. 79i and 79j.
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    The SEC also has jurisdiction over mergers and acquisitions and 
certain affiliate transactions proposed by utility holding companies. 
However, the SEC's regulation of non-utility investment is often an 
area where the SEC has exclusive jurisdiction, and poor non-utility 
investment decisions represent a risk factor in the electric utility 
industry.
    MBIA has encouraged state commissions and other stakeholders to 
file comments in SEC proceedings, to present any concerns and questions 
about non-utility ventures. However, the fact remains that the SEC has 
routinely approved most applications filed under PUHCA. But, given that 
the SEC often has exclusive jurisdiction to examine these acquisitions 
and financings, it is important that concerns about non-utility 
investment be effectively addressed.
    The proposals of multi-state holding companies, or holding 
companies that are registered under PUHCA, are of particular importance 
to state utility regulators since states tend to have less regulatory 
authority over these multi-state entities. Moreover, even if a holding 
company is exempt from PUHCA due to its status as a primarily 
intrastate entity, this status does not guarantee that state 
commissions will be able to effectively monitor or regulate the non-
utility business of utility holding companies, even under current law.
    The prospect of PUHCA repeal has taken on a different aspect in 
light of the deterioration of the financial strength of utilities. In 
recent years, PUHCA repeal has been viewed as the removal of a barrier 
to deregulation, with state regulators and FERC presumed to step in and 
fill the gap. However, the financial distress experienced by the 
utility industry even with PUHCA in place raises a compelling question: 
without PUHCA, what limits will exist on the ability of holding company 
systems to shift debt and risk to utilities and away from non-utility 
subsidiaries? Although not strenuously enforced in recent years, PUHCA 
has served as somewhat of an inhibiting factor on utility investment in 
non-utility businesses--and non-utility investment in utilities. 
Without the constraints of PUHCA, FERC and state regulators will be 
hard-pressed through existing regulatory authority to achieve the level 
of effective corporate and financial separation MBIA believes is vital 
to the health of utilities. Even with PUHCA, state regulators have had 
to struggle to protect utilities. For these reasons, MBIA favors PUHCA 
reform, rather than repeal.
    To the extent that there is an effective ``gap'' in regulation of 
non-utility diversification, we believe that Congress must fill the gap 
and ensure that regulated utilities are not harmed by the non-utility 
side of a holding company's business. Congress should not prohibit the 
intermingling of utility and non-utility businesses in the same 
corporate family, but it should enact legislation that places 
conditions on holding company acquisitions and financings of non-
utility investment, to help to ensure the financial health of the 
regulated utility. MBIA supports the transfer of PUHCA's consumer and 
investor protections to FERC.
    For instance, Congress should empower the federal regulatory body 
with authority over holding companies with the authority to require 
that the utility subsidiaries be properly financially separated from 
non-utility affiliates. To the extent that a utility merges with, 
acquires or is acquired by a company with non-utility subsidiaries, 
federal regulators should be empowered to condition such transactions 
with the requirement that state regulators of utilities within a 
holding company system have sufficient authority to protect the 
regulated utility from harm that non-utility affiliates can cause. FERC 
should have the authority to review transactions between a utility and 
its affiliates, to guard against cross-subsidization. Legislation 
should require that state commissions and/or FERC have sufficient audit 
authority, and full access to the books and records of the holding 
company and its entities. In addition, legislation should require that 
holding companies maintain separate books and records for non-utility 
and utility entities.
    Whether or not PUHCA is ultimately repealed by Congress, we believe 
it is important that such requirements be in place. Proper monitoring 
and treatment of non-utility ventures can only be achieved if the 
appropriate regulators have the tools to be effective.
Congressional Action Needed
    In closing, I would like to commend the Committee for recognizing 
the importance of addressing the financial distress in the utility 
industry. A financially imperiled utility erodes investor confidence, 
which can lead to higher rates and service and reliability problems. 
Federal and state regulators have a role to play in helping to ensure 
the financial health of utilities, but Congress must also act to 
provide regulatory certainty and fill any regulatory ``gaps.''
    MBIA recommends that Congress enact legislation to accomplish the 
following:

   Clarify FERC's authority to protect the financial health of 
        the regulated utility, in the context of Section 203 
        transactions under the Federal Power Act.
   Reform PUHCA and transfer its consumer and investor 
        protections to FERC, including authorities related to 
        securities issuances, mergers and acquisitions, affiliate 
        relationships, and the financial separation of the utility from 
        non-utility affiliates.
   Help ensure that state commissions that regulate the rates 
        of utilities within a holding company system have sufficient 
        authority to protect the regulated utility from harm that non-
        utility investment can cause. Conditions on holding company 
        acquisitions and financings of non-utility investment should 
        include the following:

          Requirement that state commissions have sufficient audit 
        authority.
          Requirement that state commissions have full access to the 
        books and records of subsidiaries within the holding company 
        system, and the authority to review the relationships of 
        utility and non-utility subsidiaries.

   Require that holding companies maintain separate books and 
        records for non-utility and utility entities.

                                    
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