SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 3764 words

COMMITTEE: HOUSE ENERGY AND COMMERCE

SUBCOMMITTEE: ENERGY AND AIR QUALITY

HEADLINE: IMPACT ON EURON BANKRUPTCY ON ENERGY MARKETS

TESTIMONY-BY: MR. RICHARD C. GREEN, CHAIRMAN

AFFILIATION: UTILICORP UNITED INC.

BODY:
February 13, 2002

Statement by Mr. Richard C. Green Chairman UtiliCorp United Inc.

The Committee on Energy and Commerce

Thank you, Chairman Barton, Representative Boucher, and members of the Sub-Committee. I appreciate the opportunity to testify on behalf of the Electric Power Supply Association (EPSA) this afternoon. EPSA is the national trade association representing competitive power suppliers, including independent power producers, merchant generators and power marketers. EPSA members provide reliable, competitively priced electricity from environmentally responsible facilities in U.S. and global power markets. EPSA recognizes that competition has brought many benefits to our customers, and seeks to continue the delivery of benefits to customers as competitive markets continue to develop. Based in Kansas City, UtiliCorp United Inc. is an international energy and services company with customers and operations across the U.S. and in Canada, Europe, New Zealand, and Australia. Our Aquila, Inc. subsidiary is one of the largest wholesalers of electricity and natural gas and providers of risk management services in North America, the United Kingdom and continental Europe. UtiliCorp also owns traditional investor-owned utilities in mostly non-urban areas of Missouri, Kansas, Colorado, Nebraska, Iowa, Michigan and Minnesota as well as utilities in Australia, New Zealand and Canada. At September 30, 2001, UtiliCorp had combined total assets of $11.9 billion and 12-month revenues of $42.3 billion. UtiliCorp plans to adopt "Aquila"as its corporate name later in this first quarter to more accurately reflect our increasing focus on our wholesale energy and risk management business.

My great-grandfather, Lemuel Green, started the predecessor to our first regulated utility in 1908. What started as a small family business has grown substantially due to UtiliCorp being in the forefront of change in the competitive global energy market place. I have served as the CEO of UtiliCorp from 1985 through 2001, and the Chairman since 1989. I also serve on the U.S. Department of Energy's Electricity Advisory Board.

The Enron bankruptcy has shaken the confidence of government, investors, employees and the capital markets. The tragedy delivered to Enron employees, and shareholders, and the communities they served is terrible.

The Enron bankruptcy has raised questions about how the wholesale market physically works, the trading of energy, the security of pensions for employees, and corporate ethics. It is imperative that we all work together to answer these questions.

Our knowledge of the energy markets and the facts reported to date indicate that Enron failed due to questionable non-core business investments and inadequate reporting practices of financial information to investors, shareholders, and employees that dramatically reduced investor confidence. Enron did not fail because it was in the energy marketing business. The underlying business practices of Enron would have created the same result if their core business had been real estate development, software products, or sporting goods.

Despite the shock of the Enron bankruptcy, the energy markets did not panic. The energy market---in terms of delivering power and gas to customers in a reliable and efficient manner has continued without interruption. The market was stable and customers were served without interruptions. Enron was a significant competitor to Aquila's wholesale energy and risk management business. At its peak, Enron was responsible for approximately 20% of the trades in the energy market. Despite the loss of the largest participant, liquidity was maintained and there were no significant swings in prices or disruptions in the supply of gas or electricity. In this regard, the energy industry did not miss a beat. The competitive wholesale market continued to do business as usual.

The energy market, particularly from the customer's point of view, remained stable---without interruption of services because of the liquidity and stability provided by the marketplace. When Enron's situation became apparent, other parties stepped in to fill the void. The market offered choice and diversity. Cautiously, companies began to adjust their positions and move business to alternative companies and electronic trading platforms. It is a testament to the strength of the energy markets, that in only a few short weeks, the industry could adjust to the collapse of a significant player with little effect on the customer.

Energy trading volume moved seamlessly--demonstrating the market diversity---from EnronOnLine, Enron's proprietary electronic trading platform, to other open many-to-many electronic trading platforms owned by a group of shareholders such as the Intercontinental Exchange (ICE), in which my company has a minority ownership interest. Total volumes on ICE increased by 65% from October to November 2001. During that time as well, the number of ICE users increased by 30%. Specifically, ICE saw an increased volume of gas and power trades for next-day as a result of the need to replace Enron volumes. Formerly EnronOnLine provided much of this market liquidity. The ability to move to other trading platforms did not destabilize the energy market. In fact, "choice" promoted stability.

As a result of the Enron collapse, questions have been raised about the use of derivatives and accounting disclosures of derivatives. I urge members to distinguish between derivatives themselves and these accounting disclosures. Derivatives, as financial instruments, first evolved in the 1850s after the railroads and telegraph communications developed on a widespread basis. With available transportation to move agricultural products a long distance and the advent of telegraph communication, farmers could sell their crops while they were in transit or before the crops were harvested. The derivative tool, when used as a hedging instrument, removed exposure to fluctuating prices from the farmer's income. As noted by the acclaimed historian, Alfred Chandler, "the standardizing and systemizing of marketing procedures carried out by the exchanges transformed methods of financing and reduced the costs of movement of American crops." The use of derivatives evolved well beyond agriculture to numerous industries such as metals, banking- --for exchange rate fluctuations, and energy.

The use of derivatives helped to stabilize the markets after Enron's collapse. Derivatives are financial tools, reflecting the underlying value of the commodity, that allocate risk and promote liquidity. I would agree with Energy Secretary Abraham's remarks, recently appearing in The Washington Post, that the pioneering work in energy trading, particularly derivatives, played a central role in providing market liquidity and risk allocation during the Enron collapse.

I would also agree with the National Association of Regulatory Utility Commissioners' (NARUC's) recent comments on derivatives. NARUC adopted a resolution, passed by their Board of Directors in July 2001 that "recognizes the important use of financial and physical mechanisms to reduce electricity and natural gas market volatility". The NARUC resolution states that that these financial instruments are a "component of a comprehensive energy procurement program." Furthermore, NARUC states "that the Board of Directors of NARUC, urges each State Commission to explore and examine the potential benefits to consumers and distribution utilities of using financial and physical mechanisms to hedge against market volatility in wholesale electric and gas markets."

Derivatives are important to consumers and to regulated utilities in providing price stability. Furthermore, derivatives can be customized specifically to the purchaser's unique circumstances and needs. I would point out the following examples of customized derivative products that Aquila provides to help our customers, such as regulated utilities or businesses, control their risks and lower the costs to their customers.

Example #1 Example from Summer 2001): Sacramento, California's municipal utility (SMUD), pays close attention to weather forecasts. During droughts, because there is no water to go through the dam, Sacramento gets less of its electricity from hydroelectric dams and must pay higher prices for power on the short term, open market. To ease the pain of buying high-cost power during droughts, the municipal utility entered into a five- year derivative contract with Aquila. The Sacramento utility receives replacement power or cash to purchase replacement power from Aquila when measured rainfall is below a certain level. In this way, SMUD cushions the risk of a budget hit due to lower- than-expected rainfall. This allows the Sacramento utility to protect its customers from rate increases to cover the costs of purchasing last minute power at high prices on the open market when such hydroelectric generators cannot operate.

Example #2 - Production of aluminum is a very energy-intensive business. One aluminum producer traditionally obtained its electricity from the hydroelectric facilities it owned at a nearby river. As a result, it used to schedule aluminum production based on projection of that river's spring flows. In essence, their ability to produce efficiently hinged on sufficient snowmelt and rainfall to fill the hydro dams.

Today, Aquila supplies that smelter with all of its energy, so production can be based on raw material market conditions---not weather and rainfall. In exchange for the purchased derivative, customized specifically for this plant in this location, we maximize the use of energy from company's dams on the river. Of course, if the manufacturing company requires more electricity than those dams can supply, we obtain it from regional markets and other power plants at a predetermined price. This derivative "cushions the risk"for the manufacturer and its production schedule. It allows the manufacturer to be more competitive in the global market.

Example #3 - Aquila has customized a derivative product called Guaranteed Bill for the customers of a Midwestern regulated utility. Guaranteed Bill is marketed to its residential customers by the local utility. The service offers customers a fixed monthly bill for natural gas. It is designed to put the retail customer in control and allows the individual to fix his/her energy costs. Historically, a customer trying to control costs was limited to a level payment plan which offers no insulation from weather or commodity price fluctuations, only the averaging of monthly payments over the course of the agreement. With Guaranteed Bill there is no end-of-agreement "settle up"payment due at the termination of the agreement. Aquila provides the utility with a weather hedge and a fixed commodity price allowing the utility to provide its customers true price certainty.

A further illustration of the increasing recognition of the importance of derivatives is Aquila's teaming with The World Bank and the International Finance Corporation (IFC) to launch a global weather risk facility that will sell weather derivatives to companies in emerging markets. This initiative of the World Bank and the IFC has grown out of the multilateral agencies' plans to broker weather derivatives to boost agricultural yields in North Africa.

It is imperative that the value and utility of derivatives themselves not be confused with questionable accounting practices and questionable financial reporting. It is imperative that companies reports provide accurate and transparent information concerning their actions and financial health of companies.

I understand the concerns of Congress and the other regulatory agencies such as the Securities and Exchange Commission (SEC), the Federal Energy Regulatory Commission (FERC), and the Commodity Futures Trade Commission (CFTC) in considering and examining the energy industry issues and accounting and pension issues affecting all industries catapulted into the spotlight by the Enron collapse. The Enron actions have understandably raised questions about the necessary protections required for shareholders and employees.

Congress should look at several issues that will help restore their confidence in the energy industry as well as other industries in order to ensure that employees and investors are protected.

(1) The inability of Enron employees to diversify their retirement portfolios as the stock price of Enron declined having high concentration of Enron stock ownership within their portfolios must be examined and corrected. Legislation that addresses these employee concerns and allows employees at any time to diversify is needed.

(2) The standards for disclosure of special purpose entities (SPEs) and off-balance sheet financing need examination and correction. I believe that the SEC has the proper authority to make these changes that will provide for appropriate disclosure of such entities. Investors should have confidence that such entities are adequately being disclosed.

(3) The standards required for the oversight of external auditing needs examination and resolution. Currently, the accounting industry would be characterized as self-policing. The SEC has the authority to require the independent oversight of audit procedures and standards. Investors should have confidence that there is an independent oversight function. Such an independent oversight body could also review audit failures and should have subpoena power.

Aquila has made and will make every effort for full and open disclosures within the energy industry. Just recently, Aquila executives conducted a seminar for Wall Street and investment analysts about accounting methods. I believe that it is crucial that we educate these groups and others about the accounting methods and practices applicable to our industry. Our disclosure practices and communication of our financial information are not like Enron, and we find ourselves in the position of having to explain that very clearly.

Lack of confidence by the capital markets in the energy industry has been raised as a result of the Enron collapse. Rating agencies have raised the credit standard for generators and traders. There have been steep declines in stock values. There is a new appetite for a stronger capital ratio reflecting greater equity value and less debt.

This shift in the capital structure will force many energy companies to reduce debt and to scale back investments in new gas processing, development of storage facilities and pipelines, and generation plants. The result could be a shortage of generation in the long-term.

Since 1990, the competitive power supply industry has accounted for more that half of all the power generation capacity brought online in this country, and we expect this percentage to increase as competitive wholesale markets continue. The loss of confidence by the capital markets in the wake of Enron's demise will likely result in a reluctance to invest in the critical infrastructure for our energy supply and delivery. Congress can help to encourage confidence and to encourage the capital markets to invest in much-needed energy infrastructure by passing legislation to continue to make markets more efficient.

Briefly, I would commend the Bush Administration, Chairman Bingaman, Chairman Tauzin, Congressman Barton, and the Federal Energy Regulatory Commission (FERC), as well as many others, for their various proposals for new legislation that encourage a further efficient marketplace in which consumers will benefit.

The energy areas in which I would submit that you take action include: existing federal legislative reform, the standardized interconnection to the power grid, and the formation of regional transmission organizations.

Federal Legislative Reform: While PURPA in 1978 opened a new path for independent power companies to create wholesale generating capacity outside traditional utility regulation, the independent power generation industry is now mature and robust. Moreover, subsequent law enacted by Congress in 1992 effectively deregulated the creation of wholesale generating capacity. If PURPA is repealed prospectively as part of a comprehensive federal electricity bill, there must be explicit recognition and preservation of existing PURPA contracts as negotiated in good faith. I also endorse efforts to guarantee the recovery of PURPA contract costs as appropriate federal policy. However, such cost recovery must be explicitly related to the honoring of existing contracts. Moreover, the existing QF ownership restrictions in PURPA have outlived their usefulness. They are an artificial and outdated restriction on the transfer of ownership of QF facilities. These restrictions lead utilities that want to acquire QFs to resort to the use of complex, temporary, corporate shells or trusts to dilute the utility ownership below 50%. The artifices are expensive, cumbersome, and serve no apparent useful public policy.

Standardized Interconnection: The power transmission grid has been compared to the national highway system in terms of its importance to our economic infrastructure. The highway system, along with protections to promote interstate commerce, has allowed a flow of benefits between regions. The national power grid requires standardization to promote the flow of power between regions as the national highway systems supports the flow of goods and services.

I endorse a clarification and standardization of interconnection rules for new sources of power generation. I cannot overemphasize how important this issue is for investment and construction of new generation. For companies interested in expanding electric generation capacity---critical to affordable power rates throughout the country, the physical interconnection of the generation plant to the power grid has become too often the "choke point"for project development.

Ad hoc interconnection standards create uncertainty, extensive delays and unexpected or unfair costs for developers. Legislation needs to affirm the right of new generation to interconnect on a non-discriminatory basis to transmission facilities, provide a clear avenue for the federal review of interconnection policies, and establish a timely remedy, if necessary, for any abuse. Access to the transmission grid should be uniform just as entrance and exit ramps are uniform throughout the interstate highway system.

RTOs: Congress should affirm FERC's authority to order utilities and other entities that own transmission assets to join a FERC approved Regional Transmission Organizations (RTOs) in order to realize a truly open and competitive transmission grid. I am supportive of FERC's directive to organize large, regional RTOs to reflect the way power flows. Independence in operation and market monitoring are crucial for the achievement of the open access initiated by Order 888.

The nation's transmission system is in need of upgrades and new investment to take economic advantage of available and most advantageously priced generation supply. I support market-like incentives to encourage new transmission builds in place of cost- based ROE. Pricing for transmission should preclude "pancaking"(multiple charges as power flows from one transmission system to the next) which can increase costs to customers due to excessive transmission charges for the delivery of power supply. Each user of the transmission grid must be required to take service under a single open access transmission tariff. The information system that guides the reservation and pricing and rules of transmission access should be standardized to increase transparency, reduce costs, and level the playing field.

Congress should reaffirm FERC's authority to set and enforce a clear deadline for all utilities and other transmission owning entities to join Regional Transmission Organizations (RTOs).

The continued support of Congress and FERC is necessary to re- establish confidence, to foster the creation of new technologies, to attract the necessary capital for infrastructure and to ensure a robust marketplace for the future. This will result in the reliable, affordable supply of energy.

While all companies are naturally concerned about creating shareholder value, companies must demonstrate equal concern and diligence for monitoring the human capital within their organizations. A foundation principle of our company is that the best companies are those where its people are rooted in a common understanding of expectations, and share in the ownership of the company. Furthermore, when business values and codes of conduct are integrated into performance management and business processes, they serve as a system of checks and balances as these values are upheld in practice. We all must make every effort to provide transparent information that facilitates the understanding of our financial actions and their results----which earns and maintains investor confidence.

Four important stakeholders that are vital to the company's long- term success ultimately evaluate a company's success: employees, customers, communities and shareholders. Employees vote their confidence in the company by taking advantage of ownership opportunities, referring friends for employment, and advancing their career within the company. Customers show confidence in our ability to provide superior energy solutions by selecting us over others in the marketplace. Communities cast their votes of confidence by providing us with operational franchises, purchasing our services, and partnering with us on vital economic development initiatives. The value of corporate citizenship must first be demonstrated in the very communities in which we live and work. Finally, shareholders demonstrate confidence by investing in our company.

The UtiliCorp/Aquila culture identifies values that are the foundation for success. We have also recognized that by effectively executing compliance with these values, the company is creating discipline and durability to deliver performance to our stakeholder groups.

The Enron collapse is tragic for employees, their communities, and their shareholders. . Enron failed, not the energy market. We must all work together to re-establish and restore confidence so that customers will continue to benefit.

Thank you for the invitation to appear before your Committee. I will be happy to answer any questions you may have.



LOAD-DATE: February 19, 2002