Entergy Corp.'s evolution toward becoming a more modern -- and profitable -- electric utility hit a wall earlier this week when the Mississippi Public Service Commission emphatically refused to approve the transfer of Entergy Mississippi's high-voltage transmission lines to ITC Holding Inc., an independent transmission company based in Novi, Mich.
In a unanimous decision, the PSC said the deal was wrong for the state because it would have increased electricity rates and ceded control over setting transmission costs to federal regulators. The Entergy-ITC plan offered no "clear quantitative or qualitative benefits to customers," the PSC order said.
Both Entergy and ITC quickly issued statements expressing disappointment, saying they would consult to determine next steps.
The Mississippi decision could endanger the two companies' larger plan to have New Orleans-based Entergy's 15,700 miles of high-voltage lines in Louisiana, Arkansas, Texas and Mississippi spun off to ITC in a $1.78 billion transaction. ITC has 15,000 miles of transmission in six states.
The Entergy-ITC plan, first announced in late 2011, was driven by Entergy's expectations that its grid would need roughly $2 billion in upgrades in the coming years as it would also face a need for capital spending on its generation fleet. But the transaction also was designed to confer $2.5 billion in net benefits to Entergy shareholders. By contrast, the Mississippi PSC said the deal would have cost ratepayers more than $800 million over 30 years.
The chief issue for the three-person Mississippi PSC was that ITC sought to have the Federal Energy Regulatory Commission take over the PSC's job of setting rates for the cost of transmission. "Giving up jurisdiction is a big deal," said Virden Jones, executive director of the Mississippi Public Utilities staff, a body independent of the PSC that looks after ratepayer interests.
The PSC found that ITC preferred federal regulation because of a higher rate of return on equity (ROE) -- 12.38 percent -- that it enjoys on its current assets and would also in Mississippi. By contrast, the PSC has allowed Entergy Mississippi an ROE of 10.76 percent. That may seem like a small difference, but it can translate to millions of dollars in extra profit over time. Moreover, the PSC said it would no longer have a say "over what transmission costs are passed through" to consumers and it would effectively lose control over quality of service and grid reliability.
Deal still possible?
Entergy had maintained since proposing the spinoff that it could work only if the four states and city of New Orleans each approved it. Regulators in the other jurisdictions have yet to act on pending requests to transfer Entergy grid assets, but regulatory staffs in Texas and Louisiana have weighed in with conclusions that echo Mississippi's decision. Decisions by those regulators are expected in the next two to three months.
"My assumption is that no matter what they have said, the deal's still possible without certain states being part of it," said Paul Fremont, managing director at Jefferies & Co. "The transaction isn't dead until the parties declare it to be dead, and so far they haven't done it," Fremont said, although he added that if Arkansas and Louisiana follow suit and formally reject it, "then it's definitely dead."
For now, there's no immediate financial effect on the companies. Standard and Poor's credit analyst Dimitri Nikas said the Mississippi PSC decision has no immediate impact on Entergy's or ITC's credit ratings, which are, respectively, BBB and A-. Approval of the deal "was never part of the base case scenario" for S&P's setting of Entergy or ITC ratings.
Nikas said "regulators in the Southeast have been a lot more guarded [than other states] about conceding control" of transmission to FERC. He doubts that Entergy and ITC would consider a smaller deal excluding Mississippi, saying the "value proposition for ITC starts to decline."
One easy option for Entergy and ITC is to ask the Mississippi PSC for a rehearing. But "I don't see our commission doing anything different," the public staff's Jones said.
Earlier DOJ concerns
Entergy has been arguing that the spinoff was necessary to assuage concerns by the Justice Department that Entergy had been for a decade engaging in anti-competitive practices in the Southeast. Entergy disclosed in October 2010 that DOJ had a civil investigation underway into whether it had unfairly denied merchant generators access to its transmission system.
To partially appease DOJ, Entergy agreed to move control of its transmission system to the Midcontinent Independent System Operator (MISO), effective at the end of this year. As Jefferies' Fremont said, "The DOJ probe prompted the move to MISO in the first place; that has always been the plan A remedy."
While the companies might argue that the spinoff would help, "I don't think anybody ever argued that this is necessary in order to clear DOJ concerns," Freemont said.
A veteran Washington, D.C., attorney who has closely followed the proposed spinoff, speaking on the condition of anonymity, said Entergy and ITC "read this thing really poorly. There just was no give on anything. How could they get this wrong?"
The companies resisted suggestions earlier in the year by Mississippi stakeholders to modify their proposal and improve its chances of approval. "They weren't the least bit interested in even having one sentence of a conversation about the jurisdiction remaining in Mississippi," the attorney said.
Noting that Entergy "has done just fine" financially by state regulators, the attorney placed the blame on ITC for wanting the higher FERC rates. "ITC's entire strategy is based on telling Wall Street that it will unlock the value, and Wall Street understands unlocking the value as moving things to a FERC context where the ROE is higher," he said. "And that's the bottom-line reason. It's money, it's money; it's always been money. Nobody called this a close question. The order is uncompromising. I just don't see how they're going to put this thing back together."
As for where the possible failure of the spinoff leaves the DOJ probe, the attorney said, "maybe the Justice Department might not push its luck too far and wait to see" how the integration of the Entergy grid into MISO works out and how Entergy behaves in the regional transmission organization. "My guess is they'll call Entergy in and they'll say, 'This is a sword of Damocles hanging over your head, and we're going to watch your behavior in MISO; don't test our patience on this.'"
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