Mr. Chairman and members of the Committee, I am David Sokol, Chairman and CEO of MidAmerican Energy Holdings Company, a diversified, international energy company headquartered in Des Moines, Iowa. I am here today representing MidAmerican and other "exempt" utility holding companies that support S. 206.
Thank you very much for the opportunity to testify this morning on an issue of great importance to my company, and I believe, the American energy consumer. I would like to thank Senator Hagel for that very kind introduction and I am pleased to say that I am also a constituent of Chairman Enzi’s. I would like to commend the Chairman and the members of the subcommittee for calling this timely and important hearing.
MidAmerican Energy Holdings Company consists of four major subsidiaries: CE Generation (CalEnergy), a global energy company that specializes in renewable energy development in California, New York, Utah, Texas, Arizona and Nevada, as well as the Philippines; MidAmerican Energy Company, an electric and gas utility serving the states of Iowa, South Dakota, Illinois and a small part of Nebraska; Northern Electric, a competitive electric and gas utility in the United Kingdom, and Home Services.com, a residential real estate company operating in, among other states, Maryland, Kentucky and Indiana. CalEnergy owns and operates geothermal power plants in the Imperial Valley of Southern California. The Company is the largest employer and taxpayer in Imperial County, one of the most economically disadvantaged counties in the state of California.
I would like to focus my remarks on providing the committee with some real-world examples of how the Public Utility Holding Company Act (PUHCA) is limiting investment in energy infrastructure and reducing the supply options for American consumers at the very time when the industry needs new investment most.
I have just returned from spending a week on the ground in California, observing first-hand the chaotic situation in that state. The causes of the California energy crisis are numerous and complex, but I believe they can be tied to two core problems – 1) lack of adequate investment and infrastructure in the energy sector and 2) regulatory policies that distort energy markets.
Concerning investment and infrastructure, California enters this summer approximately 5,000 megawatts short of expected peak demand. Even with heroic efforts to reduce demand, it will be difficult for the state to avoid blackouts this summer. Critical shortcomings in electric transmission such as the well-examined bottleneck along "Path 15" reduce the ability of the system to move power efficiently.
With regard to regulatory policies that distort energy markets, California took a number of steps which proved disastrous. In the name of reducing concerns about utility market power, the state either compelled or encouraged large-scale generation divestitures by the incumbent utilities and required those utilities purchase power in the volatile spot market. The state restructuring legislation also mandated significant rate reductions that discouraged new entrants from competing for retail customers. Combined with PUHCA’s limitations on selling electricity generated by exempt wholesale generators (EWGs) at retail and the inadequacy of available transmission and generation, this helped smother retail competition at the residential level in its infancy. Also, almost all observers would agree with my view that the state’s failure to preemptively address the excessive bureaucracy in its plant siting and environmental review procedures was a major shortcoming in California’s restructuring plan.
In its review of the energy situation in California and the West last year under Chairman Hoecker, FERC found, "there is little doubt that the most crucial task ahead is to ensure that a robust supply enters this market, both now and in response to any future price signals." Nationwide, data from the North American Electric Reliability Council (NERC) project electric reserves of only 11.48 percent in 2001, with electric demands increasing by more than two percent per year. Typically, a 15 percent reserve is considered to be the minimum to ensure reliable service. Conservative estimates show that more than $76 billion will need to be invested in the sector by the end of the decade to assure reliable service.
As this Congress considers the actions it can take to ease the energy crisis in California and the West, I believe you will see that PUHCA contributes to both of these problems. The law can and should be repealed, and only Congress can do so. To do otherwise would leave a federal statute on the books that will continue to inhibit investment and distort markets in the West and throughout the country. The results of California’s failure to address these issues in advance of the onset of full retail competition should be a warning to Congress about the need to move quickly on removing barriers to investment and market entry.
On a more specific level, I would like to provide the committee with two concrete examples of how the Act prevents actions that could help alleviate the California electricity crisis.
Last summer, we at MidAmerican began to see signs foreshadowing the severe problems that have afflicted the California electricity market. The investor-owned utilities in the state had already begun to suffer financially from the impacts of soaring wholesale electricity costs and capped retail rates. Since MidAmerican is a privately-held company whose largest shareholder is Berkshire Hathaway, we enjoy the benefit of substantial financial resources and the ability to take a long-term investment horizon. We gave serious consideration to a number of options that would have involved MidAmerican taking an equity position in the California utilities while working with the state to return the market to long-term viability.
Every scenario we reviewed ran into the same roadblock – the Public Utility Holding Company Act. MidAmerican is exempt from the most intrusive regulatory restrictions of the Act because its regulated utility business is primarily in one state, Iowa. However, MidAmerican could not acquire more than 4.99 percent of the equity in any of the California utilities without running afoul of PUHCA on several fronts. It also is my understanding that a number of other utilities considered taking similar actions either individually or as part of a consortium, but ran into the same PUHCA roadblock.
First, the physical integration requirements of PUHCA would have required MidAmerican to demonstrate that it could physically interconnect its utility systems in the Midwest with those of the California utilities. This is an impossible standard for MidAmerican to meet. Any other public utility, registered or exempt, operating within the eastern two-thirds of the United States would run into the same barrier.
Second, even if we could have solved the problem of the physical integration requirement, MidAmerican would have been forced to become a registered holding company under the Act. This probably would have required the Company to separate itself from Berkshire Hathaway or have Berkshire divest itself of all non-energy related assets. I’m sure I don’t have to explain to the members of the Senate Banking Committee why neither of those options was even momentarily considered.
In fact, the arrangement that allows Berkshire’s interest in MidAmerican is probably the most extreme example of the so-called "PUHCA pretzel" where holding companies are forced to contort themselves organizationally to avoid violating the law or registration under the Act. Berkshire Hathaway owns approximately 90 percent of the equity in MidAmerican, yet controls less than 10 percent of the voting interest in the company. Mr. Walter Scott, also of Omaha, holds the majority of the control of the Company at the Board level. Only by such structuring could Berkshire Hathaway make an investment in a regulated utility and avoid having to divest itself of its diversified holdings. This arrangement works because of the extraordinary level of trust and respect among the small number of owners of MidAmerican, but it should not be necessary. The Company is structured this way for one reason and one reason only – the arbitrary requirements of PUHCA.
I hope you will take a moment to reflect on the absurdity of this. Berkshire Hathaway is one of the most financially stable private entities in the world, with a AAA bond rating. A federal law enacted more than 65 years ago with the intent of protecting investors keeps MidAmerican and Berkshire out of California’s utility market and almost prevented Berkshire from investing in MidAmerican. At the same time, the California utilities are unable to pay their dividends or even their bills, with cascading effects throughout the economy.
Another example pertains to our interest in expanding the Company’s Imperial Valley geothermal plants. These plants currently provide the California electricity market with approximately 300 megawatts of baseload, emissions-free, renewable electricity. We would like to double the size and output of these facilities, providing desperately needed electricity to the California market.
In order to get this electricity to consumers in Southern California, additional transmission will need to be built. As you are well aware, the state’s investor-owned utilities are in no financial condition to undertake this type of project. The obvious answer would be for CalEnergy to make the investment in the transmission lines necessary to connect these plants to electricity consumers. Unfortunately, PUHCA may stand in our way.
Being an owner of a transmission facility in California creates similar PUHCA problems to investing in a California utility. Once again, the Company would be faced with maneuvering around the physical integration standard and dealing with Berkshire Hathaway’s diversified portfolio. There may be some way around these problems, and we will explore every option to find a way to complete this expansion. Nonetheless, the existence of this unnecessary, outdated law makes it far more difficult to invest in this critical industry.
One final item the Committee should consider related to California is what will happen to the utility companies in the state once stability is returned to the marketplace. These companies face a long climb back to fiscal health, and will have a difficult time raising capital for new infrastructure. Yet, PUHCA will prevent most if not all domestic utilities, and discourage non-utility companies, from making equity investments in these companies for the reasons already discussed.
Where will needed capital come from? I anticipate one of three sources. First non-utility companies could make these investments, but these companies will not have the benefit of prior experience in the industry and will be impeded by PUHCA just as Berkshire Hathaway. Federal or state governments are another possible source of capital. But, the political issues would seem to make that unlikely. The most likely scenario, I believe, is that foreign utility companies looking for a foothold in the U.S. market will take long looks at these companies.
Since these companies are not restricted by the physical integration requirement on their "first bite" entry into the American market, they will enjoy a substantial advantage in the mergers and acquisitions market. I’m not making a case against international investment. In fact, I strongly support it. But outdated, unnecessary laws should not hamstring American companies in this competition.
Are there any good reasons not to repeal PUHCA?
I don’t believe so.
1) The SEC has consistently supported PUHCA repeal for almost twenty years.
Speaking on behalf of the SEC at a hearing of the House Subcommittee on Finance and Hazardous Materials, Commissioner Isaac C. Hunt, Jr. testified, "by the early 1980’s, the SEC had concluded that the 1935 Act had accomplished its basic purposes, and its remaining provisions, to a large extent, either duplicated State or Federal regulation or otherwise were no longer necessary to prevent the recurrence of the abuses that led to its enactment…Therefore, the SEC unanimously recommended that Congress repeal the statute."
Commissioner Hunt continued, "In the summer of 1994, the SEC staff, at the direction of Chairman Arthur Levitt, undertook a study of regulation of public utility companies which culminated in a June 1995 report. Based on the report, the SEC has recommended that Congress consider three legislative options for eliminating unnecessary burdens. The preferred option is repeal of the 1935 act, accompanied by the creation of additional authority to exercise jurisdiction over transactions among holding company affiliates. This course of action will achieve the economic benefits of unconditional repeal and also protect consumers." That is exactly the approach embodied in S. 206.
2) The bipartisan leadership of this committee also has consistently supported repeal.
It’s a tribute to the ability of this committee to work on a bipartisan basis toward good policy goals that both the Chairman and Ranking Democrats on the Banking, Finance and Urban Affairs Committee are co-sponsors of this bill. I believe it’s also a testimony to the strength of the arguments for PUHCA repeal that senior members of the committee who have heard both sides for years, join in support of PUHCA repeal.
3) Federal Energy Regulatory Commissioners have consistently supported repeal.
On March 20, 1997 FERC Chair Elizabeth Moler, a Democratic appointee, testified, "as presently structured, the Public Utility Holding Company Act inhibits competition. Congress should eliminate these impediments. Utilities need the freedom to pursue structural changes without facing antiquated rules that do not easily accommodate current policies favoring competition." At the same time, Independent Commissioner, Donald Santa, Jr. testified, "this anachronistic federal statute no longer serves any useful purpose and, in fact, is an impediment to greater competition in electricity markets." The current Chairman of FERC, Curt Hebert, is also a strong proponent of PUHCA repeal.
PUHCA repeal will make it easier for FERC to continue policies to promote efficient, competitive wholesale markets. PUHCA is premised on geographically limiting utility companies while at the same time FERC is working to reduce market concentration.
The limits PUHCA places on FERC’s ability to promote competitive wholesale electricity markets are even more apparent today. PUHCA inhibits utilities’ efforts to comply with FERC Order 2000 to establish independent regional transmission organizations (RTOs). Every non-utility participant in the electricity debate favors the establishment of RTOs to ensure the most efficient use of the electric transmission system and to guarantee that utilities do not use control of the transmission system to distort wholesale electricity markets. Every consumer group, every industrial user group, public power entities and rural coops all strongly support moving forward with RTOs.
Many utilities, including MidAmerican Energy, are working to establish independent transmission companies, or "transcos," that would provide for efficient management of transmission networks in large regional markets. As FERC strongly prefers that these organizations be large, multi-state companies, they will be subject to PUHCA’s restrictions. This discourages investment and delays the day we will see operational control of transmission fully separated from competitive market functions.
4) PUHCA repeal is pro-consumer.
Repealing PUHCA will allow new investment, new ideas and new efficiencies in the electric and gas industries at a time when these are needed most. Last year, MidAmerican commissioned an independent study by the highly respected econometrics firm Analysis Group/Economics. Using the most conservative possible estimates, the study demonstrated directs costs to the economy of hundreds of millions of dollars annually from PUHCA. Other surveys that have attempted to quantify lost opportunity costs in the industry have estimated a multi-billion dollar annual drag on the economy from PUHCA. I am pleased to provide our study to members of the committee for your review.
Why then has PUHCA not been repealed yet?
Because PUHCA repeal is a hostage to other aspects of the larger electricity debate. Other stakeholders in the industry have sought to use PUHCA as leverage to achieve their goals in energy policy. I don’t say that in an accusatory sense. That’s the way the game is often played, and MidAmerican has taken a leadership role in trying to resolve policy differences on the full range of these issues.
Those efforts can and should continue, but I believe both Congress and the stakeholder community need to step forward and focus on what they support and are willing to help get passed. We need to end the politics of stalemate where interest groups have focused more on blocking progress on one another’s priorities than on moving forward with good policy. Unfortunately, the losers in this hard-played game have been America’s energy consumers.
Mr. Brunetti’s company, Xcel Energy, is a registered holding company subject to the most stringent restrictions of PUHCA. In spite of the fact that our companies are regional competitors on the wholesale market, I support his company being removed from PUHCA’s onerous restrictions. He supports my company being able to expand beyond its limited geographical scope and become a larger competitor in the Midwest and Great Plains. By removing both our companies from PUHCA constraints, you will enable each of us to compete more aggressively, operate more efficiently and serve consumers better.
Last year, I joined Mr. Warren Buffett in discussing PUHCA repeal with House and Senate leaders. In those meetings, we warned that the energy sector was headed for a train wreck in either California or the Midwest. I don’t take any pleasure in being right in that prediction, but I hope you will understand why I believe so strongly Congress must act now.
The political game that has held PUHCA repeal hostage has been well-played on all sides, but the big loser has been the American consumer. It’s time to change the way the game is played. I thank you for the opportunity to testify this morning and ask you to support S. 206.
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