Failed merger calls acumen of utility CEOs into question

CEG-FPL deal had to weather planned 72% rate rise in election year

analysis

October 27, 2006|By Paul Adams | Paul Adams,Sun reporter

In the heat of last spring's political feud over rising electric rates, Mayo A. Shattuck III, Constellation Energy Group's chief executive, grinned before the cameras in Annapolis and conceded that he was "terrible" at politics.

Lewis Hay III, Shattuck's counterpart at FPL Group Inc., is known for telling colleagues and media that he "abhors" politics and bureaucracy.

But when it comes to the energy industry, winning over regulators and the politicians who appoint them is everything, making it a big part of a utility CEO's job.

Shattuck and Hay have done that successfully in the past. But their failure in navigating Maryland's political environment in part led to the merger's undoing.

The merger was called off by the companies Wednesday, during a year when electric rates were set to rise by a record amount, the result of legislation passed in 1999 after lengthy hearings.

The utility commission responsible for deciding its fate was already under suspicion for a series of staff firings by a Republican chairman that were called politically motivated.

And the deal was launched at the beginning of what many consider the most contentious campaign season in recent memory, with a Republican governor fighting for a second term in a state where Democrats have dominated the scene for a generation.

"It's one of those situations where everything that could go wrong, did go wrong," said H. Russell Frisby Jr., a Washington attorney and chairman of the Maryland Public Service Commission from 1995 to 1998.

In hindsight, it would seem that the energy executives should have known better than to try to pull off one of the largest utility mergers on record in the midst of so much political quicksand.

"I've been scratching my head over that one," said Michael Powell, an attorney who represents clients in Annapolis and before the utility commission. "It really surprised me that they would pick that time to announce the merger."

As often happens in the corporate world, the focus is on spreadsheets and economic ratios rather than the political equation that underpins many deals.

Similar miscalculations have led to the demise of numerous mergers guided by what all believed to be knowledgeable industry veterans with flawless records. This one was no different, some industry analysts and political veterans say.

"Hindsight is always terrific, but did anybody know there was going to be a 72 percent increase [in electric rates]?" said Gary Alexander, whose firm lobbied for FPL and served as its legal counsel in Maryland. "Did anybody realize the incredible partisanship and divisiveness of an election year? Who knows."

But it was plain to most industry experts and utility officials in the weeks before the deal was announced that customers of Baltimore Gas and Electric Co. were heading for a huge rate increase that would coincide with the beginning of the legislative session.

Months earlier, Hurricanes Katrina and Rita had decimated natural gas production in the Gulf of Mexico, sending fuel prices into record territory. Natural gas is burned to make electricity and is a key driver of prices in the wholesale electric market, where deregulation rules required BGE to shop for its power starting this year.

The resulting 72 percent rate increase came as lawmakers were looking to gain some advantage heading into campaign season. They needed a wedge issue, and they found it in electricity.

Still, Constellation officials surveyed the landscape and decided to go for the deal anyway, reasoning that trying to time a merger is an imprecise science, at best, and poor business, at worst.

"I think that every business decision that we make has a risk-reward trade-off, and in this case we chose to take the risk and it didn't work," Shattuck said in an interview after the merger was called off Wednesday. "It's not as if we were unaware of the risks and issues going into this whole process."

FPL's Hay had a similar take on the issue of timing in an interview during the legislative session last spring.

"Both Mayo and I went into this with eyes wide open," he said. "In theory, we could have tried to just delay and not do the deal until all this stuff cleared up. But one thing I find in business is that you always have to address whatever issues are facing you today, because there are always going to be new issues tomorrow and it's impossible to predict what's next."

On paper the deal was unassailable, analysts said. The combined companies would have dominated the unregulated and rapidly growing wholesale power market. They could boast that deal was destined to leave them with the strongest balance sheet in the industry.

But in the public arena it looked to many like a grab for profits at a time of soaring residential electric rates.

In a recent interview, Hay said it was a conscious decision for FPL to stay on the sidelines while the political drama in Maryland played out.

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