The Impact Of Self-dealing

Electric utilities across the country are being required by state lawmakers to make alternative sources of power and services available to customers. Midway through 1999, 21 states had passed restructuring statutes and three states had issued final rules by the regulatory authority phasing in competition among energy services providers. The most common response of utilities has been to transfer assets to a holding company and organize operations into separate regulated and unregulated wholly owned subsidiaries. The motivation for forming a holding company is perhaps best explained in what Constellation Energy published on its home page at after it was formed from the Baltimore Gas & Electric Company in April 1999. "BGE's traditional regulated business of providing electricity and natural gas to customers in its service territory is being opened to competition. Partially in response to this competitive environment, BGE has increased its unregulated, energy-related business. "Since we anticipate that in the future the capital needs of the unregulated businesses will be greater than that of BGE, the holding company structure will separate the operation of the regulated business from the unregulated businesses, allowing Constellation Energy Group to raise capital for its unregulated businesses in the public markets, which is more efficient and cost effective. In addition, the capital structure of each unregulated business may be tailored to suit its individual business. These factors will enhance Constellation Energy Group's competitiveness. "A holding company structure is common for companies engaged in multiple lines of business and is preferred by the investment community because it is easier to analyze and value individual lines of business. The holding company structure also makes it easier for regulators to assure that there is no cross-subsidization of costs or transfer of business risk from unregulated to regulated lines of business. Finally, a holding company structure provides the regulated utility legal protection from the results of unregulated business activities." ( This strategy is called "self-dealing" and is perfectly legal under current federal rules. As competition among deregulated utility subsidiaries heats up, contractors may get caught in the crossfire of deregulated utility subsidiaries that market their new services nationwide. The market power of utilities that are permitted to finance competitive activities with resources gained from regulated monopoly operations presents a daunting challenge to contractors. Knowledge is power Both outside energy competitors and state-licensed electrical/mechanical contractors need a level playing field that is not definitely tilted in favor of incumbent utilities. But, incumbent utilities argue that using utility employees for dual assignments, i.e., systems maintenance and customer services, or assigning capital equipment part of the time to unregulated subsidiaries is more cost effective and helps preserve their jobs, as well as protects stockholders' interests. In looking at this issue, the Michigan Public Utilities Commission staff noted that arrangements that tie unregulated subsidiaries too closely to the parent might be violations of Section I of the Sherman Act and Section 3 of the Clayton Act. These antitrust laws have been touted as promoting particular social objectives such as limiting business size, protecting small business from large corporations, and expanding opportunities for entrepreneurs. However, in recent years, courts have taken a more narrow approach in interpreting these statutes, and "populist" objectives have largely been left up to the marketplace. State public utility commissions have been reluctant to regulate nonutility activity of holding companies unless real and direct harm to rate payers is proven. Utility defense includes the right to compete with normal practices although that may prove harmful to a competitor. As the courts have interpreted antitrust laws, they offer little protection for small business firms that must compete with large corporations. According to Anthony M. Ponticelli, executive director of the Alliance for Fair Competition, " The antitrust laws protect competition, not competitors, regardless of whether they are large or small. We do not seek protection from competition, but from unfair competition." Take FirstEnergy, for example Utilities contractors in Ohio, and a 13-state region in the Mid-Atlantic and Eastern United States may be inclined to be concerned by FirstEnergy. Created in 1997, with the merger of Ohio Edison, Pennsylvania Power, Cleveland Electric Illuminating, and Toledo Edison, FirstEnergy has gone on an acquisition binge in 1998-1999, buying nearly a dozen electrical and mechanical contractors. The company serves more than 2 million customers and has more than $18 billion in assets. Acting in conjunction with several other construction trade associations, the Ohio Conference of NECA has brought a complaint before the Public Utilities Commission of Ohio (PUCO) against FirstEnergy. Allied with NECA are associations representing the state's mechanical contractors, general contractors (Associated General Contractors), roofing contractors, air conditioning contractors, plumbing-heating-cooling contractors, and consulting engineers. These groups are together under the appellation "Ohio Construction Trade Associations." FirstEnergy is alleged to have violated sections of the state law "by providing services that are not in the tariff nor otherwise approved by" PUCO. The complaint makes other charges against the utility: "In the process of transitioning into deregulation, the FirstEnergy companies have engaged in abusive marketing practices by using assets and revenue from their monopoly services. They have responded to the new competitive market structure by diversifying into nonregulated construction business including sales, installation, maintenance, and repair of heating, air conditioning, lighting, and other commercial and residential electric equipment. "Traditionally, Ohio Construction Trade Associations' members perform these nonutility services across Ohio, typically acquiring the work through both public and private competitive bidding. However, the FirstEnergy companies perform these nonutility services at a reduced cost or zero cost, causing monopoly resources to be employed either directly or through an affiliate. "The FirstEnergy companies cross-subsidize select affiliated construction services in many ways, including: * Financial subsidization of customer credit, billing, materials, and labor; * Use of confidential market data or customer lists; * Advertising nonutility services through 'bill stuffers' when the same promotions are not made available to competitors; and * Providing free personnel, equipment, and office space" (to the affiliates). Here are a few allegations from the complaint filed with PUCO: 1.A public school organization canceled a purchase order with a NECA contractor under which the contractor was to have furnished and installed transformers. The letter informed the contractor that Toledo Edison (another FirstEnergy subsidiary) was doing the work. 2. The Toledo-Lucas County Port Authority amended its agreement with Toledo Edison to include construction of street, roadway, and area lighting at port authority facilities without competitive bidding. The five-year amendment concerns lighting owned by the authority, not the utility. Under the state's law, the complaint contends, the utility should not be doing such work. 3. The complaint presented Toledo Edison advertisements and bill inserts that showed the utility was offering zero percent financing "without disclosure of implicit financing costs based on rate funding." The zero percent financing was offered for installation of outdoor lighting. Funding terms were said to include 48-month interest-free financing. 4. In a specific 5kV power line relocation project from a private company, Toledo Edison's bid was 50 percent lower than that of the next lowest of four contractors bidding, "evincing cost reduction based in large part upon the rate-payer subsidy of labor costs in offering the deregulated activity," the complaint alleges. 5. On an installation of 51 pole lights at a nursing home, the lowest contractor bid $31,500; Ohio Edison bid $5,800. For a proposed additional project involving installing 39 alternate pole lights, Ohio Edison's bid was $4,000; the lowest contractor came in at $40,000. You may conclude that this snapshot of what FirstEnergy is doing in Ohio is a local problem. It is not. FirstEnergy has bought contractors in several states, all of the contractors large and reportedly prosperous. The company acquired an electrical/mechanical/service contractor organization with $420 million in annual sales overnight - using a strategy not all that much different from that used by the publicly held "roll-up" companies. Consider what it would be like to have this huge, aggressive utility come to your state. It is entirely possible: FirstEnergy has targeted a 13-state Mid-Atlantic/Eastern region, extending eastward from Indiana to Maryland, for energy sales and contracting services. What's more, FirstEnergy is creative. In May, it introduced an "Advantage" program inside Ohio, targeting 238,000 small-business customers. Partners in providing these services include big names: AT&T, Airborne Express, Sunoco, The Hartford, U.S. Office Products, and Compaq. The program will enable the utility to offer the following nonutility services: * Property insurance * Health benefits * Fuel * Overnight delivery * Wireless telephone service * Personal computers and office supplies Daunting challenge A total of 24 states now have adopted rulings scheduling competition for the energy services business. However, only a few state regulators have actually issued implementing rules. Although there may be no effective rules for deregulation in nearly half the states, many utilities are acting as if they already exist. The bottom line is this: contractors now face a new world that boils down to a marketing war between David and Goliath. Moreover, you can guess who is who. Still, recall from that ancient story that David won the battle with Goliath. Contractors are not without market power or strategic competitive options. However, they must use the right armament and load it with the right ammunition. The challenge may be daunting, but results could be exciting for those willing and able to find the opportunity in change, rather than to focus entirely on the threats. TAGLIAFERRE, proprietor of the C/E/C Group in Springfield, Va., compiles news about the impact of utility deregulation for Electrical Contractor. He can be reached at (703) 321-9268, or by e-mail at Portions of this article will appear in "Surviving Utility Deregulation," research currently being conducted by The Electrical Contracting Foundation.

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