Monday, August 27, 2007

PUC bares weak teeth on TXU deal - In notes, regulators worry about how to protect public

By ELIZABETH SOUDER - The Dallas Morning News - Sunday, August 26, 2007

On the Friday in February when news leaked of a record-breaking offer to buy TXU Corp., the company's top government liaison met with the state's top utility regulator to alert him of the deal.

Then Paul Hudson, chairman of the Public Utility Commission, spent the weekend worrying. The commissioner's job is to protect the public. But a loophole in the state law that deregulated the electric industry makes the commission virtually powerless to block a merger that might harm consumers.

"It is fair to say that the more I think about our discussions yesterday, my concern grows," Mr. Hudson wrote in an e-mail to Curt Seidlits, TXU's senior vice president for government advocacy, that Saturday.

On Monday, Feb. 26, TXU officially announced the $45 billion offer from Kohlberg Kravis Roberts & Co. and TPG. In a conference call with analysts, TXU made it clear that the buyout wouldn't require PUC approval.

The announcement rattled consumer groups and some lawmakers. Some proposed a bill that would expand the PUC's authority over transactions. But TXU lobbyists persuaded legislators to apply the new rules only to future utility deals, leaving the door open for the TXU sale.

Commissioners can only try to persuade the buyers to be good to consumers, or else face a web of bureaucratic rules and procedures.

Trouble is, commissioners know that putting an investor through a bureaucratic gauntlet would backfire. If investors pull out of Texas, there will be no one to finance the new power plants and electricity wires the state needs to support a growing population. Commissioners call it the "death spiral."

The three commissioners and their staff met with buyout officials more than a dozen times during March to suggest ways the investors could protect the public from unfair rates, unreliable service or dwindling competition in the industry.

Within weeks of the announcement, the investors gave commissioners and staff an initial list of commitments meant to show that the out-of-state investors cared about Texas.

Mostly, the buyers pledged to do things that appeared to be part of their business strategy anyway: Rename each business unit, cut prices, build only three of the 11 proposed coal-fired power plants and avoid saddling TXU's electric delivery unit, Oncor, with excess debt.

According to e-mails and meeting notes reviewed by The Dallas Morning News, the commissioners weren't satisfied. They worried that debt costs might rise due to the buyout and that the reliability of Oncor's portion of the power grid might suffer.

Mr. Hudson asked the investors to put "more flesh on commitments," according to meeting notes taken by a PUC staff member March 26.

And he worried about a much larger issue: whether the buyout of the state's biggest power company might shake the stability of the entire industry. He told the investors that the retail and wholesale portions of the deal were not "off the table," according to the notes.

Mr. Hudson has sounded more aggressive than the other commissioners when he talks about how far a new utility investor should have to go. During meetings, he's brought up the idea of a "net benefits" test – that is, requiring an investor to show that it would bring a benefit to the public.

The other two commissioners have said it's probably OK if the investor simply shows it won't harm the public.

Wires and poles
Since deregulation, PUC's main thread of power over the utility industry is in the wires and poles part of the business, such as Oncor.

It has little power over the vast electricity generation part of TXU's business, called Luminant, or its retail company, called TXU Energy. Those parts of the business are free to compete in an unregulated marketplace.

But delivery companies are still monopolies, and PUC sets the rates they charge.

So as TXU was selling itself to private equity companies, the corporation had to notify PUC that Oncor was being sold. The commission will hold a hearing on the filing in October.

If the commissioners find the sale, due to close by year-end, isn't in the public interest, they still can't block it outright. They can only refuse to allow the new Oncor owners to pass along certain costs to ratepayers. The commission still sets Oncor's rates, which represent a sliver of consumers' bills.

Commissioner Barry Smitherman, a former investment banker from Houston, calls the rate tool a "meat ax," hardly an effective way to protect the public. Squeezing profit leaves a company with less money to invest in more power lines, harming the reliability of the entire system.

Mr. Smitherman spoke to the TXU investors about ways to protect Oncor in case TXU's other businesses go bust, and about employment and reliability, according to notes from a March 21 meeting. He didn't talk to them about making promises for the retail or wholesale businesses. In fact, the notes show the meeting concluded with a discussion of how to limit the scope of the proceeding.

The third commissioner, Julie Caruthers Parsley, doesn't appear to have done much persuading at all. The propriety of talking to the investors about the filing makes her uncomfortable.

The News requested all correspondence and calendar entries for commission and staff about the TXU buyout. The request yielded only one calendar entry showing a meeting between Ms. Parsley and KKR representatives, and no correspondence between Ms. Parsley and the buyout group.

"It's totally appropriate, but I'm a little more cautious on those sorts of things than other commissioners have been," Ms. Parsley said in an interview.

"In a legal world, if I know I'm going to file a lawsuit, I can't go up to a judge I hope I'm going to be assigned to and say, 'Hey, I'm going to have a case and I'm going to file it in your court next week, and how do you think you're going to respond?' "

Negotiating ends
The negotiating time ended April 25 when the buyers filed official notice with PUC of a change in Oncor's ownership. Commissioners aren't allowed to talk about pending cases.

Oncor's filing included a few promises that addressed commissioners' concerns, such as limiting the debt costs that Oncor would pass along to ratepayers and continuing to invest in power lines. Also, Oncor is to negotiate commitments with other stakeholders, such as labor groups or consumer advocates, about employment, customer service and reliability.

But the buyers went no further with their commitments concerning the retail and wholesale businesses at TXU.

The next time someone wants to buy a regulated power line company in Texas, things will be different.

The Legislature passed a law last spring to require utilities to gain prior approval by the PUC of the sale of a wires and poles business. The law doesn't apply to pending acquisitions, including the TXU buyout.

Passing the law took all session. As the commissioners worked out their buyout issues with the investment group, they also helped lawmakers draft bills.

On the day TXU announced the deal, Sen. Troy Fraser, R-Horseshoe Bay, filed Senate Bill 896, originally designed to give the commission the authority to investigate instances of market manipulation. It picked up an amendment giving the PUC authority to block a merger or acquisition.

Unhappy senator
Mr. Fraser was already unhappy with TXU over accusations the company had manipulated the wholesale market (TXU denies doing so). He made a scene at a hearing last summer when he accused TXU chief executive John Wilder of unfairly hiking electricity rates.

The buyout group tried to cool Mr. Fraser's frustration by letting him know about the deal before the news hit. A few days before the announcement, investment group officials tracked Mr. Fraser down in Ruidoso, N.M., and interrupted his ski vacation to talk about their plans.

Still, Mr. Fraser worried publicly that the buyout might harm consumers.

"He has everyone spun up on the transaction and is pushing for a pre-merger approval amendment on one of the bills," a TXU official wrote in an e-mail to a PUC staff member.

Then Washington took note of the deal, and things got more complicated. In early March, U.S. Rep. Joe Barton, R-Ennis, sent a letter to Mr. Hudson threatening to end Texas' autonomy over its electric grid if the commission didn't scrutinize the deal closely. Texas is the only state that has its own grid, separate from the rest of the country.

"I will not ... stand idly by while investors from New York or anywhere else benefit on the backs of the Texas electricity grid or the Texas ratepayers," Mr. Barton said in the letter.

Big guns arrive
It was time to bring out the big guns. The buyers sent Wall Street rock stars Henry Kravis and David Bonderman, the leaders of the private investment companies that want to buy TXU, to Austin to shake some hands.

"Dear Mr. Kravis: Thanks for coming by today – it was a real treat to visit with you and David," Mr. Smitherman wrote in an e-mail to Mr. Kravis the evening after their meeting. Mr. Smitherman's own banking career ended when he was fired for publicly criticizing the Houston mayor.

Mr. Kravis responded: "At any time you want to reach out to me, please feel free to contact me. I will get back to you if I am tied up when you call."

By the end of the Legislative session in May, the buyout crew had persuaded a number of decision-makers to leave the deal alone.

Mr. Fraser's bill giving the PUC authority to block the deal died in the House. The amendment to expand PUC powers over transactions got tacked on to another bill and passed.

But here's the out for TXU: The law specifically says it doesn't apply to any deal filed with the commission before May 1, 2007.

The commission could still make things uncomfortable for TXU's new owners. Commissioners have lined up several pending cases that indirectly affect TXU and could be used to slap the new owners on the hand if they get out of line.

"Like any competitive environment, basketball game, football game, there are a set of rules that market participants have to follow, and if they cheat, they should be punished," Mr. Smitherman said, describing his view of the PUC's job.

The commissioners meet every couple of weeks to a packed house on the seventh floor of a state office building down the street from the Capitol.

TXU often sends a dozen people – executives, lawyers and designated liaisons. They sit on the second row to the commissioners' left.

(A PUC meeting is a bit like church. Regular attendees have their regular seats, and only visitors would disrupt the seating arrangements.)

Sending a message
Earlier this year, the commission worried that Oncor was earning too much and decided to review the company's rates for delivering electricity over power lines. The review has nothing to do with the buyout, since the commission would only consider last year's finances. But the PUC could use the review to send a message to the new owners.

"We probably don't get to a hearing until this spring. It may be even a better opportunity to take into account the effects of the [buyout] filing since we're going to conclude that one in the fall," Mr. Hudson said during a meeting in August.

The commission can't tell TXU Energy, the retail electricity provider, how much to charge. Instead, the PUC is considering changing its rules for certifying retail providers that have more than 1 million customers, which includes TXU Energy. The commission could review the finances of a large retail provider, establish additional requirements and delay certification.

And the commission has an important pending case against Luminant, TXU's competitive wholesale business.

PUC staff accused TXU of manipulating the wholesale market, and the commissioners must decide whether to punish the company. If the commission finds that TXU manipulated the market, it could fine the company a record $210 million.

The commissioners did offer the investors some clarity on one pending issue, which may indicate they are feeling comfortable with the deal.

After the PUC accused TXU of manipulating wholesale markets, the company wanted to reach an agreement on trading power in a way that the commission would find acceptable. The commission agreed.

If TXU sticks to the agreement, the commission cannot accuse TXU of market manipulation.

Former PUC Chairman Pat Wood called the wholesale agreement a "seminal event" for the deal. Shareholders will vote whether to accept the buyout Sept. 7.

"That does 10 times more than this merger-of-the-wires-business hearing that they're going to have later this fall, as far as investor comfort," he said in an interview.

Barry Smitherman: 'Liberated' by his employer after an opinion piece on Houston, he says he's pursuing his real interests.
When Banc One Capital Markets fired Barry Smitherman in 2002 because he wrote an opinion piece for the newspaper complaining about Houston's financial condition, Mr. Smitherman finally had time to finish his book, If Jesus Were an Investment Banker.

The book describes Christ's leadership qualities and includes the idea that often it's OK to fire people because it allows them move on to work that better suits them. Mr. Smitherman calls it "liberating" employees.

Mr. Smitherman had worked his way up the investment banking ladder to become managing director of the municipal bond department in the Chicago office.

He didn't think his hometown of Houston was getting a good deal on its bonds, so he helped write the opinion piece for the Houston Chronicle with some City Council friends. Later, Mr. Smitherman considered running for mayor himself, but he hasn't pursued that idea yet.

The opinion piece upset folks at City Hall, which upset some of Mr. Smitherman's colleagues, which upset his employers, who quickly liberated Mr. Smitherman from his position.

Mr. Smitherman moved his family back to Houston, found a job as assistant district attorney and began scouting for political appointments.

Originally, Mr. Smitherman applied to the governor for a regent posting at his alma mater, Texas A&M University, among other jobs. He filled out the four-page application by hand in his quick, deliberate print.

The governor eventually appointed Mr. Smitherman to the PUC instead.

The liberation from banking "turned out to be a blessing for me," Mr. Smitherman said. "I would have never become a prosecutor, which was, when I went to law school, really what I wanted to be. I ended up going for the money instead of the prosecutorial role right out of school."

Still, Mr. Smitherman refers to that opinion piece as the "one that cost me a couple million dollars."


Age: 49

Hometown: Houston

College: Texas A&M University, Class of 1980

Graduate work: University of Texas School of Law, Harvard University School of Government

Friends in high places: Sen. Kyle Janek helped him get the PUC appointment; former Houston City Council members Mark Ellis and Michael Berry helped write the opinion piece.

Membership: Former member of the C Club of Houston, a group of 100 local businessmen who support conservative candidates; director of Ballet Austin

Political contributions: $11,500 to Gov. Rick Perry since 2002, $3,725 to the C Club since 2000

Appointed to PUC: 2004

Term ends: August 2007, but he remains on the commission until the governor appoints someone else.

Julie Parsley: Texas' former solicitor general basks in the glory of standing before the Supreme Court. Julie Caruthers Parsley keeps a large framed drawing in her office of a shining moment in her career: the day she argued a case before the Supreme Court. And lost.

Ms. Parsley argued in 2002 that when there's a lawsuit against a state, the state should be allowed to shift the case to federal court without waiving the state's immunity from being sued in federal court. Confusing? The Supreme Court didn't follow the logic, either.

Still, the day stands out in Ms. Parsley's career as Texas' solicitor general, and she beams when she describes it.

"I got lots of questions. I got a sentence out, then Scalia and Rehnquist were talking to each other about how bad our position was. 'They're talking out of both sides of the mouth!' ... And I said, 'Your honors, I respectfully disagree,' " she said. "It was great."

It wasn't the only time the nation's top court turned Ms. Parsley down. She also appealed a 2001 decision that required Texas to retry a death row inmate whose lawyer fell asleep during the trial.

Ms. Parsley argued that the inmate had to prove that his lawyer's behavior affected the outcome of the case, similar to the way a court would handle a drunk or mentally ill lawyer. The Supreme Court declined her appeal.

Ms. Parsley said her whole family accompanied her to Washington for her big day, even her parents and in-laws.

Just last year, her husband, Lee Parsley, nearly became a justice himself. Mr. Parsley, a lobbyist, ran for a seat on the Third Court of Appeals and lost.

When a utility company, such as TXU, disagrees with a decision by the Public Utility Commission, the company may appeal to the Third Court of Appeals.

Ms. Parsley said her husband would have recused himself from any cases that involved her. She said she didn't help much with his campaigning or fundraising.

Still, Mr. Parsley attracted a $1,000 donation former TXU chief executive Erle Nye, who says he contributes to lots of judicial candidates because he thinks the races are important.


Age: 45

Hometown: Baytown

College: Texas A&M University, Class of 1984

Graduate work: Texas Tech School of Law

Friends in high places: U.S. Sen. John Cornyn, Railroad Commissioner Victor Carrillo

Prior job: Solicitor general

Appointed to PUC: 2002, reappointed 2005

Term ends: September 2011

Paul Hudson:
Don't make him the center of attention – or even snap his photo – but chat him up about policy. Frederick Hudson, who goes by his middle name, Paul, hates having his picture taken.

So in the PUC meeting room, among the photos of commissioners, past and present, there's a gap where Mr. Hudson's photo should be.

Julie Parsley once filled the space with a doctored photo of Mr. Hudson with Elvis-style hair. That picture quickly vanished.

Since then, the PUC chairman filled the gap with a child's drawing of a wind farm given to him after a public appearance.

You see, Mr. Hudson has no political ambitions. He's a policy guy. He spent most of his career behind the scenes, advising the governor and former utility commissioners.

He won't talk about his hobbies or how he spends his free time. That's private. He doesn't have a résumé handy to give to a reporter. And he hardly ever consents to interviews.

After four years as a commissioner, feeling the pressure from legislators and the governor's office, industry groups and the media, Mr. Hudson thinks wistfully about the careers he almost pursued, long ago, in other lives.

At 19, he trained to be a firefighter in Austin. He left shortly after the training was over to finish his education.

Then he studied to become a teacher. But after completing student teaching in a low-income area where some high school kids were reading at second-grade level, Mr. Hudson walked away from that career as well.

He's considering returning to the classroom after his PUC stint is over. Next time, he'll probably be on a college campus.

Mr. Hudson wonders if he should have stuck with firefighting. He could have retired this year, with 20 years on the job. The photo hanging in his office of his firefighting training class is probably the only picture of him in the building.


Age: 39

Hometown: Austin

College: University of Texas at Austin, Class of 1991

Graduate work: Arizona State University

Prior jobs: Director of policy for Gov. Rick Perry

Appointed to PUC: 2003

Term ends: 2009
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