By JOHN JACOBS
Jacobs is a lifelong West Virginia resident, manufacturer and exporter of fine hardwood veneers (retired) and international markets specialist. "I pay for utilities the same way you do," he says.
FirstEnergy Corp. came to West Virginia late, at the top of the market for coal-fired electricity generators and bought its way in by paying too much for now antiquated money-losing assets. FirstEnergy reported losses of over $6 billion in 2016 in a market where coal, its primary fuel, is dirt cheap.
Without a bailout prospects are grim. FirstEnergy's survival depends, not on earnings which will be years in coming, if at all, but on continued access to credit markets. Therefore, costs born and bonds guaranteed by West Virginia's credit-worthy ratepayers must seem rather attractive – in the corporate suites. On the other hand, West Virginians themselves may see that a little differently.
The Corporate Lay of Land
FirstEnergy (NYSE: FE), headquartered in Akron, is a holding company that owns and operates 10 subsidiaries including Allegheny Energy Supply in Ohio, along with Monongahela Power and Potomac Edison, which operate in West Virginia. Mon Power and Potomac Edison filed an application in March to purchase Pleasants Power Station from Allegheny Energy Supply for $195 million. Pleasants Power Station is a coal-fired generating plant near St. Mary's, WV, that opened in 1979.
Keys to Understanding the Deal
FirstEnergy CEO Charles E. Jones has been clear about the need to exit deregulated markets during investor conferences.
- Electricity rates in Ohio are deregulated. FE's subsidiary Allegheny Energy Supply (AES) sells electricity into the grid, PJM Interconnection (PJM), which buys electricity at lowest bid. If sales do not cover costs shareholders suffer.
- Electricity rates in West Virginia are regulated. FE's subsidiaries Mon Power and Potomac Edison sell electricity to PJM and purchase electricity back from PJM to meet customers' needs. Customer rates are established by the Public Service Commission (PSC) to cover all costs, ensure reliable electric supply, and provide a rate of return to company shareholders; today, 9.9%.
- Natural gas and horizontal drilling have revolutionized the cost of electric power generation. In 2008, over 50% of electricity was generated by coal. By 2016 that was down to 30% and gas up to 34%.
- Utility sized wind and solar generation are competitive now and their prospects are even better.
- The cost of wind energy has declined 66% since 2009.
- The cost of utility sized solar energy has declined 85% since 2009.
- FirstEnergy Solutions (the competitive markets subsidiary) medium and long bonds are trading at distressed levels; 40% of par. Bonds guaranteed by WV ratepayers should be expected to do better.
The company wants to transfer risk to West Virginia ratepayers. This is not an arm's length transaction in which each company can negotiate a mutually beneficial agreement. All three FirstEnergy subsidiaries must comply with a single larger corporate objective. Nor is it a paper transaction in which assets are transferred from one division to another.
This is a purchase in which Mon Power and Potomac Edison will finance the purchase from another FE subsidiary. WV ratepayers will be responsible for that financing as well as for operational costs, improvements, and a guaranteed return to FirstEnergy shareholders and investors.
- Mon Power gets a fixed asset (plant) and a liability (debt).
- Allegheny gets a current asset (cash) and liquidates a fixed asset (plant).
- FirstEnergy gets $195 million of borrowed money for which WV ratepayers are responsible.
- WV ratepayers get a $195 million continuing financial obligation (a long-term liability) and will pay expenses (current liabilities) plus a return on capital for an otherwise money-losing enterprise and a weak 16-month promise which appears to be premised on unrealistic short-term projections ignoring the higher future costs of maintaining and operating an aging facility.
A Case of Deja Vu
In a nearly identical 2013 sale Mon Power acquired Harrison Power Station for $1.2 billion. The Harrison transaction was overvalued by $578 million (called an acquisition adjustment). At the time, the addition of that 1,476 MW to Mon Power’s generation portfolio was said to be necessary and would be “more than enough to meet its 2026 projection of need.” The companies' analysis concluded that acquiring Harrison would be cheaper than buying in the market, building new capacity, converting existing stations to use other fuels, or promoting efficiency.
Because of the Harrison deal:
- Our rates went up.
- From October 2013 to June 2016, WV ratepayers have paid an additional $160 million above what that electricity would have cost on the spot market.
- WV ratepayers assumed an ongoing responsibility to service $858 million in new debt.
FirstEnergy’s chief nuclear officer Sam Belcher said, “Our plants have been losing money. We’ve continued to operate them at a loss. But, at some point, those economics don’t make sense.” He's right. But also, at some point, it doesn't make sense for WV ratepayers to continue to absorb FirstEnergy losses.
Risky business. Fool me once, shame on you. Fool me twice, shame on me!
Disruptive technologies abound
FirstEnergy’s business model is busted… and it's turtles all the way down. The coal industry is in a depression. Our coal miners are broke, employees are out of work, pensions and healthcare are on the dole, and the tax revenues which would support that – all gone. Companies who have been reliant on the coal industry, like FirstEnergy, are going to find things difficult. Before the coal industry gets back on its feet energy markets will be transformed.
West Virginia, always overly reliant on coal, must face those realities too. Perhaps worse than the immediate economic consequence of a FirstEnergy bailout is an anti-competitive subsidy to aging technology which delays adoption of the cleaner more efficient energy that we've wanted since the 1960's and the negative repercussions a bailout would be to the development of a more diversified more resilient economy.
West Virginia has become the largest producer of shale gas in the country. Already, there’s a vision to transform Chemical Valley into Petrochemical Valley with ethane storage and distribution hubs. Those may be pipe dreams, and certainly, there will be associated problems. Importantly, the trend toward renewables, wind and solar, is more promising still. We are almost completely in the dark as to those possibilities. Major companies like Amazon and Google are insisting on their use. These changes will be transformative to our economy.
Opportunity is at our feet, but we must reach for it. It will not fall into our laps. We can be assured nothing good will happen if we remain constrained by old thinking and if the investment is limited by anti-competitive policy or the need to service unproductive debt. The danger is finding ourselves in investment limbo as the business climate is perceived as being too late for coal and too soon for alternatives.
FirstEnergy is unprepared for the transition taking place in energy markets. West Virginia will benefit more from having local utilities with strong balance sheets able to adapt to and prosper from the new realities we face. A FirstEnergy bailout in which West Virginia is used as a dumping ground for distressed assets works counter to those objectives and is not in the public interest. It's a move in the wrong direction.