The Galveston County Daily News

Texas’ mammoth deregulated electricity market already is plagued by fears that it’s not competitive. Especially when power is in high demand, the biggest generators know they can get almost any price they want for their electricity because the market has to have it.

And the buyout last month of the state’s largest power company will only ensure the market will stay that way, some experts and lawmakers fear.

The buyers are inflating the stock price and taking on $24.5 billion in new debt. They wouldn’t do so unless they were sure they could get that money back — most likely from high electricity rates, observers say.

That might explain why the buyers lobbied so hard to stop measures intended to make the market more competitive.

A SURE THING

The object of the buyout, Dallas-based TXU, has seen its profits skyrocket along with electricity prices since the Texas market was deregulated five years ago. It is now fighting a finding by state regulators that it withheld power to drive up prices when demand peaked in the summer of 2005.

The Public Utility Commission in March proposed to fine the company $210 million. Then in September, it lowered the proposed fine to $171 million. It’s still $161 million more than the commission’s largest previous fine, against Enron.

In its decision, the commission is, in effect, saying that TXU controls too much of the state’s electricity generation for the wholesale market to be truly competitive.

It said the company used its “rational bidding strategy” to inflate prices on the spot market by $70 million and its own profits by $20 million during the summer of 2005. And that was just during a four-month period and only on the spot market. Economists say that high prices on the spot market ripple out over the other 90 percent of the wholesale market and into the retail market, inflating prices there as well.

The spot market is a wholesale auction conducted every 15 minutes to cover the market’s last-minute needs. TXU had used its rational bidding strategy since shortly after John Wilder took over the company in 2004.

The company fiercely disputes that its strategy amounts to market manipulation. Instead, it says, it’s a perfectly legitimate effort to recoup the considerable costs it incurs generating power — especially when it has to bring old, inefficient plants on line when demand spikes.

However, the fact that TXU’s profits during the hot summer of 2006 were $1 billion might contradict its claim that it’s simply recovering costs if it used the strategy. TXU refused to say whether the strategy remained in effect after 2005.

The utility commission maintains TXU’s rational bidding strategy is anticompetitive because the company is inflating prices on the knowledge that the market needs its power.

That effective corner on the market happened 84 percent of the time when prices spiked in the summer of 2005. When that happens, TXU can get any price it wants. Retailers who buy that power then pass the price along to their customers.

If the market weren’t forced to buy power from TXU, the high prices would mean that it wouldn’t sell and thus become a total loss for TXU, the commission says. In other words, the rational bidding strategy would be irrational in a truly competitive market.

A TEMPTING INVESTMENT

Conditions in Texas’ deregulated power market and TXU’s profitability have made the company an attractive target for investors.

A month before the utility commission accused TXU of fixing the market, news came that private investors Kohlberg Kravis Roberts & Co. and the Texas Pacific Group were putting together $45 billion to buy TXU, take it private and then resell it – presumably at a huge profit.

It wouldn’t be the first time the investors profited wildly in the Texas electricity market.

In 2004, Kohlberg Kravis and Texas Pacific bought the power plants that had formerly been owned by Houston-based CenterPoint Energy for $3.65 billion. A year later, the investors sold the plants to New Jersey-based NRG for $8.8 billion, achieving a 140 percent profit on their investment.

NRG will turn to ratepayers to extract the $5 billion profit the investors got out of the deal, Tyson Slocum of the consumer group Common Cause said last year. Those are the same ratepayers who already are paying CenterPoint $2.3 billion for the value the plants supposedly lost as a result of deregulation.

When investors completed the TXU buyout this month — and changed the parent company’s name to Energy Future Holdings Corp. — it was the largest leveraged buyout in world history.

In making the investment, the private firms put up a small portion of their own money. The rest came from sources such as state pension funds that The New York Times says are increasingly desperate for big returns to cover unfunded liabilities.

Observers say that in making the bid, the investors are assuming that Texas’ deregulated electricity market will be profitable enough to cover all the new debt they’d be loading onto TXU.

In other words, the deal amounts to a $45 billion bet that the Texas power market isn’t going to get any more competitive and electricity prices aren’t going to get much cheaper, said Douglas Jones, an economist who formerly directed the National Regulatory Research Institute at Ohio State University.

In the deregulated part of Texas, electricity bills have gone up between 67 and 114 percent over the past five years. And consumer groups fear that the buyout will only send them higher.

The day the deal was announced, it amounted to a 25 percent premium over the company’s stock price. Those billions will have to come from somewhere before investors earn a penny in profit.

SALES PITCH

Meanwhile, consumer anger has risen along with utility rates. But that anger — and demands to “fix” the deregulation law — were frustrated during the 2007 session of the Legislature.

As part of a public-relations blitz, Kohlberg Kravis sent former Secretary of State James Baker III around Texas, drumming up goodwill for the deal.

The would-be buyers also curried favor with environmental groups by promising to slash the number of coal-fired power plants TXU planned to build from 11 to three. But many lawmakers and lobbyists were deeply skeptical that the company ever intended to build that many greenhouse gas-spewing plants.

And the buyers pledged to cut power rates by 10 percent into 2008.

But in that promise, too, there is less than meets the eye, said Tim Morstad of the Texas chapter of the American Association of Retired Persons.

Even though Kohlberg Kravis aired TV commercials in the Houston area touting the plan, it would apply only to TXU’s Dallas-area customers. And of them, it only applied to those who hadn’t switched power companies as a result of deregulation.

What’s more, even a 10 percent cut locked those customers into a rate that was far more profitable for TXU than one that would result from a truly competitive market, Morstad said.

STATEHOUSE FIGHT

But the investors focused their hardest sell on Texas lawmakers.

When the Legislature began its biennial session in January, some influential members went to Austin armed with proposals to make both the wholesale and retail markets more competitive. They had been getting an earful from constituents who were incensed over their power bills.

State Sen. Troy Fraser, R-Horseshoe Bay, sponsored the 1999 law deregulating the Texas electricity market. But the chairman of the Senate Committee on Business and Commerce had for months been furious over TXU’s spiking prices and profits — and over allegations that the company had fixed the market to get them.

One measure he introduced would have forced TXU to sell off power plants until it had no more than 25 percent of the generating capacity in a given region. It now has 45 percent of the power in its home area around Dallas.

That’s far more than it needs to be able to ask any price it wants in periods of high demand, said Kenneth Rose, a senior fellow and researcher at the Institute of Public Utilities at Michigan State University.

Another bill Fraser introduced would allow the utility commission six months to review the TXU buyout and give the agency the power to approve or disallow it.

Not surprisingly, the investors who bought TXU didn’t like Fraser’s bills. Their agreement to buy the company said they could call it off if the bills passed.

“That’s their gravy train,” Fraser said during the session of TXU’s effective corner of the generation market.

His bills enjoyed strong support from his colleagues. In March, when the measures came to a vote in the Senate, they passed unanimously.

U-TURN

But a funny thing happened on the way to the House.

Rep. Phil King, R-Weatherford, had introduced a bill that was identical to Fraser’s capping how much generation a company can own. A week after Fraser’s bill sailed through the Senate, King was asked if he was getting much pressure from lobbyists for TXU and its would-be buyers.

“Only all day every day and all night every night until I turn my phoneoff,” he said.

The next day, King chaired a hearing of the House Regulated Industries Committee. Testifying was Henry Kravis, business superstar, big political donor and founding partner of one of the firms that ended up buying TXU.

With his net worth estimated at $2.6 billion, Forbes Magazine says Kravis is the 107th richest man in the country.

Kravis was flanked by Texas Pacific chief David Bonderman, another investment superstar. Behind the men were members of the all-star board they want to run the new TXU, including Donald Evans, former commerce secretary and close friend of President Bush.

During the hearing, Kravis and Bonderman argued strenuously against the bill requiring a regulatory review of the buyout.

They also said they’d run the company better than TXU’s previous management had. That’s how they would repay their debt, earn a profit and bring down electricity prices, they said. But for some reason, King’s bill requiring TXU to sell off generators never came up.

After Kravis and Bonderman departed, King reconvened the meeting and proposed to gut the measure that would have forced TXU to reduce its dominance of the wholesale market.

In explanation, King said it would be too “onerous” for electric companies.

In the end, watered-down versions of bills requiring regulatory approval of the buyout and caps on how much generation a company can own survived until the final days of the session. But then, even they died.

That means high power prices for Texas electricity customers are here for the foreseeable future, Morstad, the consumer advocate, said.