Dealmaking Power Companies Change the Utility Landscape

By Washington Investing Jerry Knight
Monday, December 26, 2005

Consumers and investors may think it doesn't matter much that Constellation Energy Group Inc., Maryland's biggest utility company, plans to merge with Florida's FPL Group Inc. Think again.

Last week's $11 billion deal to create the nation's largest seller of electricity may bode well for investors. At the very least, executives have promised to pay shareholders bigger dividends after the two companies merge next year. And because it's an all-stock deal, the merger will be tax-free for investors.

But the merger may not be such a good deal for customers of Baltimore Gas & Electric Co., the local utility company from which Constellation of Baltimore was created. The state-regulated company that provides their power will become an even smaller part of an even bigger conglomerate that makes most of its profit through unregulated energy investments.

Even before the merger goes through, Maryland's top utility regulator has begun raising questions about whether BG&E's finances have been structured to benefit its corporate parent at the expense of Maryland natural gas users.

Last week the Maryland Public Service Commission slashed $17.5 million from BG&E's $54 million request to raise natural gas rates. Gas bills will go up by about $3 a month for the average residential customer instead of the $4 that BG&E wanted.

But PSC Chairman Kenneth D. Schisler wanted the rate increase to be pruned even more to assure that Maryland consumers are not subsidizing the vast array of unregulated business run by Constellation, BG&E's parent company.

Schisler contends that BG&E is borrowing money at costly long-term rates and lending extra cash to Constellation at bargain short-term rates.

Calling this a "subsidy from BGE ratepayers to Constellation and its unregulated affiliates," he said the company's financial practices "create costs for the ratepayers, which would not occur if BGE were a stand-alone gas company."

Schisler is no anti-business bomb thrower. Like three of the four other commissioners, Schisler was appointed by Maryland's Republican governor, Robert L. Ehrlich Jr.

"We are still reviewing the decision," Constellation spokesman Robert Gould said Friday, noting that this was BG&E's first rate increase request after almost six years of steadily rising costs. "We certainly respect the process needed to give it a thorough review," he said. Providing safe and reliable service to customers remains Constellation's priority, he added.

BG&E'S central Maryland territory stretches from Harford County north of Baltimore to Howard and Anne Arundel counties, plus a sliver of Montgomery County and a big chunk of Prince George's County.

The dissent by Schisler and fellow commissioner Allen M. Freifeld, another Ehrlich appointee, raised issues never before faced by Maryland regulators.

Those same issues affect utility consumers everywhere who are served by rapidly evolving companies that are transforming themselves from local utilities into multinational energy companies.

What is now a diverse industry with lots of players, each serving its local community, is being transformed into a business dominated by regional, national and multinational giants.

Remember hometown banks like Riggs, American Security and First American? And local department stores like Woodward & Lothrop and the soon-to-be-departed Hecht's? Utilities are in the midst of the same kind of consolidation that put Bank of America and Citibank into every state in the union and left Federated Department Stores Inc. as America's only real department store chain.

More than the natural evolution of big business is behind the trend. First, many jurisdictions -- Maryland, Virginia and the District among them -- deregulated the electricity-generating side of the business. Then Congress unleashed the utilities to crossbreed and create a race of giants by repealing laws that had been on the books for decades that limited utility mergers.

Unable to resist the urge to merge, power companies have arranged several major deals this year. Exelon Corp. of Chicago has agreed to join up with Public Services Enterprise Group Inc. of Newark, N.J. Duke Energy Corp. of Charlotte plans to hook up with Cinergy Corp. of Cincinnati. Warren E. Buffett, a director and major investor in The Washington Post Co., has put together nine utilities under the umbrella of MidAmerican Holdings Corp.

Unleashing utilities to merge arguably rewrote the job description of power company chief executives. Their first assignment is no longer to provide electricity and natural gas as cheaply, reliably and efficiently as possible. Job one is to grow the company as fast as possible -- and the way to do that is by doing deals. Just a few months ago, Constellation made Fortune magazine's list of the nation's 100 fastest-growing major companies.

It's no coincidence that the chief executive of Constellation has been in the utility business for only a few years. Mayo A. Shattuck III, 51, was global head of investment banking and global head of private banking for Deutsche Banc Alex. Brown until 2001, when he joined Constellation as president. Shattuck went on the company's board just two years earlier after a career doing deals as an investment banker.

Constellation executives are so focused on dealmaking that only a month before agreeing to merge with FPL, they were trying to buy the biggest coal-burning power plant in England. In partnership with a couple of Wall Street high-rollers, Constellation offered $4.1 billion for Drax Group Ltd., whose generators light up London.

After the Drax deal fell through -- too cheap, no thanks, the British said -- Constellation hooked up with FPL.

The transaction is a true merger, not a sale disguised as one. Constellation stockholders will get 1.444 shares of the merged company for each of their Constellation shares. FPL investors will do a one-for-one swap. Shattuck will become chairman of the new company; the chief executive will be Lewis Hay III, chairman of FPL. The combined company will take the Constellation name.

Just as Constellation was formed by BG&E as a way to expand beyond its roots, FPL grew out of Florida Power & Light Co.

The merged company will have 5.5 million electric customers and power plants capable of generating 45,000 megawatts of power. Wachovia Securities analysts calculate that the new company will earn 54 percent of its profit from unregulated energy businesses and 46 percent from regulated utilities.

Debate over mixing regulated and unregulated businesses and deciding what is fair to utility customers is likely to grow more nettlesome as utility mergers continue.

Virginia could face the issue next because the state's big utility, Dominion Resources Inc., is considered a potential player in the energy merger game.

In the District, Potomac Electric Power Co. customers have less to worry about. Pepco's territory is so small and its unregulated ventures so limited that it's likely to be left out of the dealmaking.

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