Powering Up in Pennsylvania


"Provider of last resort obligation." That eerie phrase sounds like something out of a funeral parlor brochure, but it actually refers to utilities' responsibility to deliver electricity to every last customer who demands it, no matter the cost to the power company. Known as the PLR obligation, it holds true even as deregulation is opening up the market to strong competition from many new rivals.

With power supplies tightening and rate caps limiting price hikes, the PLR obligation has left some utilities wallowing in red ink. Morristown (N.J.)-based GPU Inc. (GPU), for example, lost $47 million in 2000 in the Pennsylvania market, where nearly all the utility's 1.3 million electricity customers decided to stay put or return to GPU after rate caps caused rivals to refuse to take new customers.

However, one Pennsylvania power company -- PPL (PPL), formerly Pennsylvania Power & Light -- has been tip-toeing nimbly through the minefield of deregulation, and so far has remained unscathed. PPL plans to offload the risk of its PLR obligations and steadily add to its generation capacity while consistently posting higher earnings.

INNOVATIVE STRATEGY. In 2000, PPL's net income before extraordinary items was up only 2%, to $487 million, on revenues that increased 24%, to $5.7 billion. But aided by a company stock buyback, its per-share net before extraordinary items jumped 7.6%, to $3.38. And the utility reiterated that it expects to boost earnings by 12% to 15% annually over the next few years. Impressed investors drove up PPL's share price to a 52-week high of $62.36 a share on May 23, though the price has since dropped, along with financial markets generally, to about $57.

One key to investors' confidence in PPL is the innovative way in which the utility has dealt with its PLR obligations. In late April, the Allentown (Pa.)-based company announced a securitization plan that locks in electricity rates for consumers who fall under the PLR obligation, roughly 99% of its customers. The idea is to guarantee power supplies at reasonable prices -- while avoiding potential supply shortfalls and financial losses. "It's very important to secure the energy supply for the distribution side so we don't repeat the situation in California," says Jim Abel, PPL's vice-president of finance and treasurer.

Here's how the plan works: PPL will award power contracts, probably by the end of June, which will ensure that the company has around 6,000 megawatts of additional power under contract through 2009, when the PLR requirements expire. Abel says the company has already received a number of bids on the contracts. PPL also will issue bonds to help pay for the long-term power contracts to cover its PLR obligations, as well as to retire some higher cost debt already on its balance sheet. The bonds will be secured by a lien on the assets of PPL's electric-utilities unit. The company is confident the bonds will find buyers because the utilities unit has relatively low risks and a steady revenue stream.

"FINANCIAL CUSHION." Securitization could turn into a major financial windfall for PPL, depending on what happens to spot market power prices in the future. If spot-market prices spike, PPL will look really smart for having locked in power at relatively low prices through its long-term contracts, explains Ahmad Faruqui, an economist at the Electric Power Research Institute, which is based in Palo Alto, Calif. If spot-market prices fall, however, the company can dip into the money raised in the bond issue to make up for the difference so there is no hit to earnings. "Securitization is a financial cushion," Faruqui says. Balancing long-term supply contracts against spot prices is always a gamble, but PPL is confident that it is minimizing its risks in a volatile power market. "Those are business decisions we think we're good at," says Abel.

Don't be surprised if other power companies start imitating some of PPL's strategies, notably its securitization plan. Of course, the securitization plan alone won't guarantee PPL's growth. The company now operates nearly 10,000 megawatts of capacity in Pennsylvania, Maine, and Montana. But it plans to double its capacity, to 20,000 megawatts, by 2005 by increasing generation capacity at existing plants or building new ones in other states -- which would make PPL one of the nation's top power producers. As part of the expansion, PPL has an arrangement with General Electric (GE) to lease turbine-generators. It's a valuable deal: turbine generators are a hot commodity and the waiting list of buyers is a long one. Plus, leasing the units allows PPL to conserve cash up-front and diversify its funding sources.

The company also is rapidly expanding its revenues from wholesale energy marketing and trading, which accounted for $2.1 billion in revenues last year, up from $1.4 billion in 1999. Contributing to the increase was the acquisition of Montana generation assets that are being used to supply the wholesale market in the Western United States. At that rate, the marketing-and-trading unit may soon be bigger than PPL's traditional retail electric and gas operations, which recorded revenues of $3.2 billion in 2000.

OVERREACTION Managing the rough waters of utility deregulation is never easy, however. On June 21, shares of PPL plunged 10% to close at $53 after the company

warned that its second-quarter earnings would fall short of Wall Street's expectations, and a meeting before state regulators regarding the company's securitization plan was delayed.

Barry Abramson, a utilities analyst at UBS Warburg, said investors overreacted. He noted the company reiterated its 2001 earnings-per-share guidance of $4. The company also reiterated its 2002 EPS guidance of between $4.55 and $4.65 for 2002. Although PPL didn't give the Street any second-quarter guidance initially, it did say on June 21 that results for the quarter would fall short of 77 cents per share. The Street had calculated that consensus based on seven analysts' projections according to Thomson Financial/First Call, which tracks earnings estimates.

ONE MEETING Additionally, PPL spokesman George Biechler said the company still will move forward with its restructuring efforts, including securitization. The company will have one meeting before state regulators on July 13 regarding the securitization plan and the approval of long-term power-supply contracts, instead of the two separate meetings that were initially planned.

When you look at the way PPL has weathered deregulation so far, it doesn't seem like a California-style bankruptcy risk. Instead, all the change deregulation ushers in could offer an opportunity for this feisty utility. By Heesun Wee in New York


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