Risky Business

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INTRODUCTION AND OVERVIEW: NEW RISKS AND REWARDS IN POWER GENERATION

The American electric power industry enters its second century in the grip of unprecedented competitive pressures. Power plants that have been shielded by regulation from many financial risks soon will have to survive on their own merits in an unforgiving marketplace. Recent decisions at both federal and state levels confirm that these trends are irreversible and accelerating. At stake are literally hundreds of billions of dollars in annual revenues, and access to an electricity market that today accounts for roughly one-fifth of all the world's kilowatt-hours.

We do not lack for evaluations of the competitive strength of North America's myriad power suppliers. Financial analysts produce numerous assessments of generators' prospects for success, illuminating every element of owners' fixed and variable cost profiles and their access to both retail and wholesale markets. But almost without exception, analysts and indices continue to overlook variations in generators' exposure to significant financial risks associated with future environmental regulation. For greenhouse gas emissions in particular, a growing scientific consensus and stronger U.S. leadership have made intervention increasingly certain, while underscoring markets' need for much better information about prospective winners and losers.

This report is part of an effort to fill that gap. Its author, the Natural Resources Defense Council (NRDC), has over two decades compiled an extensive record of analysis and publications regarding the electric utility sector. Our aim here is not to identify a gallery of villains (or heroes), but rather to establish a straightforward ranking of risk exposure that can and should change over time; we look forward to periodic revisions. No supplier's ranking is frozen, and abundant strategies for reducing both pollution and risk are available to every participant in the generation marketplace. Our principal aim is simply to bring more information to markets that thrive only with full disclosure. An important dividend should be increased rewards for those who can reduce emissions inexpensively within a sector that -- despite recent progress -- still dominates many of our air pollution statistics.

Several factors combine to make this initiative especially timely. Electrical generation remains, in environmental terms, one of our society's most significant activities. Suppliers vary dramatically in their emissions and their financial exposure to new controls on those emissions, given the continent's diversity in power sources and the varying extent to which suppliers depend for their electric-service revenues on sheer volumes of electricity used by their customers. New emissions controls are increasingly likely, as evidence mounts on the need to reduce risks from greenhouse-gas emissions and other under-regulated pollutants. Finally, the entire nation is on the verge of major shifts in risk allocation within power markets, reflecting the future inability of power plant owners to count on automatic recovery of costs associated with new environmental constraints. Prudent investors already have begun anticipating the transition. NRDC will help by publishing and updating rankings of emissions-based financial risk, starting with carbon dioxide.

Our initial liability rankings are attached to the body of this report. The lowest-risk institution is the nonprofit Bonneville Power Administration, which is the only large U.S. generation marketer whose power plants emit no carbon dioxide. Among the other major suppliers, exposure ratios for the least risky investor-owned utility (Pacific Gas & Electric) and the most exposed (PSI Energy, Inc.) vary by a factor of more than 25. In other words, per dollar of operating revenue, PSI-owned plants emitted more than 25 times as much carbon dioxide as PG&E-owned plants in 1995. Viewed another way, higher-risk enterprises like PSI, Ohio Power, Pacificorp and TVA have more than ten times the financial vulnerability to carbon-dioxide regulations of BPA, PG&E, Connecticut Light and Power, Boston Edison, San Diego Gas & Electric, the New York Power Authority, and Consolidated Edison.

Based on estimates recently circulated by the American Petroleum Institute, the National Association of Manufacturers, and others, the total exposure of electric generation to CO2 emissions limits or taxes could exceed $60 billion annually. The lower-risk utilities can and should take more commercial advantage of their generating portfolios' relatively low emissions; the good news for the higher-risk utilities is that much can be done to improve their positions.

We emphasize also that electric utilities are not alone in their exposure to risks associated with future environmental regulation. Similar issues will arise, for example, in many transportation and heavy industrial sectors. No one should read this report as an indictment of electricity as something that is uniquely injurious to the human environment. What is unique about utilities is their combination of sharply unequal exposure to these financial risks and highly practicable options for improving their position. An encouraging early sign is the willingness of many utilities, including some that we now rate as high-risk, to make formal commitments for emissions reductions in response to the federal government's Climate Change Action Plan initiatives. We intend to update the listings regularly and we look forward to many improved rankings (absolute and relative) as these commitments mature and expand. Increasingly, prospective investors throughout the economy will focus on opportunities to avoid or minimize the financial risks outlined in this report -- and the results should mean good news for both power markets and the communities they serve.