Duke/Progress mitigation plan: the devil’s in the details

A phrase that seems a favorite among utility industry executives is apropos with respect to the revised mitigation plan Duke Energy (NYSE:DUK) and Progress Energy (NYSE:PGN) filed for their merger: the devil is in the details.

Two months after FERC on Dec. 14, 2011, rejected their proposed plan to mitigate some of the commission’s market power concerns, the companies on Feb. 22 filed with the North Carolina Utilities Commission a new plan that adopts transmission solutions in addition to the virtual divestitures originally proposed. The latter, the companies said, serve as a “bridge” until the transmission solutions are fully implemented, which they estimate will take three years.

In order to evaluate the efficacy of the proposal, intimate knowledge of the companies’ systems is necessary, industry sources said.

“You really should understand the specifics of the engineering in the area and the effect the upgrades will have on the local system,” one industry lawyer told TransmissionHub.

He added that FERC may question the robustness of the proposed upgrades, the majority of which involve 230-kV lines. “When I think of transmission upgrades that really change the game in terms of transfer capability, you’re usually talking 345-kV and above,” he said.

The transmission component of the proposal offers two options. The first, “Group 1,” consists of three projects, and the second, “Groups 1 and 2,” adds five projects to the Group 1 projects. These measures would improve transfer capability and increase simultaneous import limits, which would “de-concentrate” the companies’ combined markets during the summer and winter periods, they said.

The three Group 1 projects comprise upgrading the transformers on Duke’s Antioch 500/230-kV line; constructing a third 230-kV line along Progress’ existing Lilesville to Rockingham 230-kV line; and adding a series reactor to one of Progress’ existing Roxboro to East Danville 230-kV lines. These projects would cost $75m.

To the extent that the Group 1 projects fail to offset “minor” market power screens, the second component of the proposal would add these five Progress Energy projects: reconductoring the Kinston Dupont-Wommack 230-kV line; reconductoring the Person-Halifax 230-kV line; installing 4,000-amp wave traps and reworking protective relays on the Wake-Carson 500-kV line; uprating the Durham-E. Durham 230-kV line; and constructing a new Greenville-Kinston Dupont 230-kV line. These projects would cost between $44m and $68m.

As none of the projects would require additional right-of-way acquisitions or certificates of environmental compatibility and public convenience and necessity, they could be completed in three years, the companies claimed.

During that three-year period, Progress and Duke, as an interim measure, would conduct firm power sales during certain peak and off-peak periods.

A second industry lawyer said FERC approval of the merger is contingent on the transmission component of the mitigation proposal.

“The commission didn’t find the virtual divestiture to be persuasive, so whether or not this gets accepted will depend on what the commission thinks about the transmission proposal,” the second lawyer said. “Sufficient upgrades will allow the import of more generation.”

He added that up to $150m of transmission upgrades was “not a lot.”

A Progress Energy spokesperson countered that a superficial assessment of project cost does not do the proposed transmission measured justice.

“If you evaluate something solely based on the estimated cost without understanding fully what the implications are, what the capacity improvements are, that’s a fairly narrow view of the efficacy of the plan,” the spokesperson said. “We believe the plan does address the concerns that were raised in the Dec. 14 order.”

He cautioned: “We’ve been surprised twice, so it’s difficult to predict precisely how FERC will respond, but we think it will be sufficient.”

An industry banker acknowledged the proposed transmission investments seemed small, but said they were “probably very system-specific, addressing where the bottlenecks are.” He noted the companies’ emphasis on these projects as upgrades to existing lines, an emphasis designed to allay concerns about completion: unlike new transmission project proposals, which require lengthy and exhaustive regulatory approvals that can drag out the process for a decade or more, these projects would be complete in three years. 

The first lawyer speculated the companies’ proposal could represent a foray into negotiations with FERC, which could request more robust upgrades. The industry banker said this was unlikely, given that was their strategy before, and it “missed the mark.” “I can’t imagine there’s a lot of time left to continue to toe the line to volley or negotiate back and forth,” he said.

The companies originally were targeting merger close at year-end 2011, and have pushed that target to mid-year 2012. Unless one of the companies was having second thoughts, the first lawyer said, they would probably want to facilitate merger close as quickly as possible.

An analyst during Duke’s 4Q11 earnings call asked whether Progress’ financial performance at year-end 2011 gave Duke pause with respect to moving forward with the merger. 

The industry banker said the companies were “full-steam ahead” and that mergers such as this tend to attract “noise,” and change the income statement “from what it otherwise would have done.”  

The merger carries a break-up fee of $675m to Progress if Duke terminates the transaction, and $400m to Duke if Progress terminates the transaction, according to the companies’ July 7, 2011 final proxy.

A third industry lawyer, echoing the two lawyers and banker, said the persuasiveness of the mitigation plan will depend on how much wholesale power from other providers the transmission upgrades will facilitate.

“The question is, what does it look like on the map?” he said.

 

This article was amended at 5:25 p.m. on Feb. 24, 2012, to include comments from the industry banker. 

About Rosy Lum 525 Articles
Rosy Lum, Analyst for TransmissionHub, has been covering the U.S. energy industry since 2007. She began her career in energy journalism at SNL Financial, for which she established a New York news desk. She covered topics ranging from energy finance and renewable policies and incentives, to master limited partnerships and ETFs. Thereafter, she honed her energy and utility focus at the Financial Times' dealReporter, where she covered and broke oil and gas and utility mergers and acquisitions.