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Regulated Utilities and Nonregulated Power Producers
In April of 2010, RRI Energy (RRI) and Mirant (MIR) announced that they plan to merge. Although each company generates electricity, it would be a misnomer to call them “utilities”. An electric utility has at least some portion of its business that is regulated: transmission and distribution, and, often, generation. These two companies are independent power producers that have no regulated utility operations. Many companies in this industry have a combination of regulated and nonregulated activities.
Even owners of nonregulated power plants have to deal with some kinds of regulation. All plant owners must follow siting, environmental, and safety requirements. “Nonregulated” means that there is no regulation limiting the profitability of these assets.
For many companies that still own regulated generating plants, such as Great Plains Energy (GXP) and Portland General Electric (POR), once they build a power plant, they need to file a rate case in order to recover the cost of their new asset and earn a return on it. (See our Internet article on utility rate cases.) There is always a risk that a portion of their investment will be disallowed for ratemaking purposes for reasons such as cost overruns, but in general, this structure is less risky than owning nonregulated power plants.
There are varying degrees of risk among nonregulated plants, depending on whether the owner has a long-term contract for the output of the plant. This is the most conservative approach. The nonregulated subsidiary of Southern Company (SO) will not build or buy a plant unless a contract is in place. By contrast, “merchant” plants bid their output into the market. Although effective hedging can lessen the market risks, this business is lucrative when power prices are high, but when prices are low, corporate profits suffer. The plants (mostly nuclear) owned by Exelon (EXC) are merchant facilities. Dominion Resources (D) owns some contractual plants in the Midwest and some merchant plants in New England.
Some electric utilities have become “hybrids” that get a large proportion (well over half, in some cases) of their income from nonregulated sources. Among these companies are Exelon, Dominion, Public Service Enterprise Group (PEG), Constellation Energy (CEG), FirstEnergy (FE), NextEra Energy (NEE), Entergy (ETR), and PPL Corporation (PPL). Even so, because each of these companies still owns electric distribution operations, we still cover them in the Electric Utility Industry in Issues 1 or 5. The companies that are entirely nonregulated, such as RRI, Mirant, and NRG Energy (NRG), are covered in the Power Industry in Issue 6.
Two electric companies, Dominion and PPL Corporation, decided that their split between regulated and nonregulated profits became too heavily weighted towards the nonregulated side. Consequently, Dominion sold its natural gas exploration and production operations and PPL will buy (subject to regulatory approval) two traditionally regulated utilities in Kentucky. Another company, Entergy, wanted to spin off its nonregulated generating assets into a separate company, but had to cancel its plans when the New York commission did not approve the company’s proposal.
Some electric utilities serve both regulated and nonregulated states. The plants owned by Duke Energy (DUK) in the Carolinas and Indiana are regulated; those in Ohio are not. Ameren (AEE) is in a similar situation, serving Missouri (regulated) and Illinois (nonregulated). Duke is constructing generating facilities to serve the Carolinas and Indiana, but is not building anything in Ohio. It remains to be seen whether companies will be eager to take the risk associated with building capacity in deregulated states, knowing that many nonregulated plants fared poorly after the power markets collapsed in the early 2000s. With forward prices in the power markets having been weak in the first five months of 2010, there is no incentive for nonregulated power producers to build, anyway.