Breaking up Constellation Energy Group and its BGE subsidiary could benefit the parent firm by freeing it from state oversight, but consumers probably would see little relief, utility industry analysts say.
Gov. Martin O'Malley raised the prospect of a split last week when he called on state regulators to examine whether Baltimore Gas and Electric Co.'s relationship with Constellation contributed to last month's 50 percent rate increase for customers of the state's largest utility. Analysts said, however, that consumers still would have to pay market rates for electricity under Maryland's deregulation laws.
Some consumer advocates cheered O'Malley's move, but it is unclear whether extricating BGE from Constellation would be a bigger victory for consumers or Constellation executives, who some say would love nothing more than to spin off BGE or sell it to Allegheny Energy, Pepco or another utility. Some analysts say BGE could be worth more than $2.4 billion in a sale.
Such a move would rid Constellation of the political baggage that comes with owning a regulated utility, leaving it free to sell itself to an out-of-town buyer or pursue other business strategies without fear of state interference. But legal experts say it is questionable whether regulators could force a breakup without running afoul of constitutional protections against government takings of property.
The debate over the utility's ownership could have far-reaching implications for the state's economy, which many say is taking a beating as a result of rising energy costs. Also hanging in the balance is the corporate makeup of Constellation, a Wall Street success story that finds its business model increasingly under attack by Annapolis lawmakers.
O'Malley's inquiry stems from concerns that Constellation's goal to sell power for the highest price the market will bear is at odds with BGE's obligation to keep rates low for its 1.1 million residential customers. The state Public Service Commission raised questions about the corporate affiliation in its recent order approving a 50 percent rate increase.
"Certainly, the concern the governor is raising has been raised in many states, in many jurisdictions at many different times, and the easiest way to alleviate that concern is to split them," said Paul Fremont, a Jefferies & Co. analyst in New York.
Potential results
A split would resolve any conflicts of interest but might yield mixed results for consumers, industry experts say. On the plus side, it could put BGE's financial interests more in line with those of its customers. For example, an independent BGE might be more willing to consider building power plants, which would compete with those owned by Constellation and earn regulated profits. Industry officials disagree whether the cost of such plants would make electricity more or less expensive for consumers, but it's an option regulators plan to explore.
BGE still would have to buy most of its electricity from Constellation, the largest supplier in a state where demand exceeds supply. And a breakup would have no effect on the price Constellation charges for electricity from its unregulated power plants, which are separate from BGE. State regulations say BGE must buy power from the lowest bidder, which in most cases is Constellation.
BGE "would have to go out into the marketplace just as [it] did last year and get bids from companies like Constellation, and we'd be in the same place we were last year," said Paula M. Carmody, the state people's counsel.
Some say a split could hasten the sale and potential relocation of Constellation, which tried unsuccessfully last year to merge with Florida's FPL Group Inc. Lawmakers effectively scuttled the deal in a dispute over BGE's proposed 72 percent average rate increase for residential customers. But their ability to do so was linked to the state's regulatory control over BGE. If the companies were separated, lawmakers would lose any influence they have over Constellation, whose wholesale power sales fall under federal jurisdiction.
"The state would lose all leverage over Constellation," said Neil Kalton, an A.G. Edwards analyst. "Conversely, you would have BGE doing all it could to lower power costs to customers, which could be adverse to the interests of Constellation. And that's the way it really should be."
The question of whether regulated utilities should be allowed to do business with unregulated corporate parents has simmered since states began opening their power markets to competition in the late 1990s. Many states that deregulated required utilities to be independent to avoid conflicts of interest. Many that didn't, including Maryland and Illinois, are reconsidering.
In its May 23 order, the PSC questioned whether BGE's relationship with Constellation hurts consumers. It noted the utility's opposition to owning power plants, which could put it in competition with Constellation as a supplier. It also raised alarms about whether at least one corporate officer has a conflict of interest when doing certain types of work for both BGE and Constellation. John Collins, Constellation's former chief risk officer, advises BGE when it conducts power auctions. Constellation is a major competitor in those auctions.
The Maryland Office of the People's Counsel, which represents utility consumers, said the commission is right to examine the relationship. But Carmody expressed concern that the inquiry would distract from the more important debate over how to re-regulate the industry to make electricity cheaper. "The question still in front of us is whether we should continue to promote retail competition in Maryland, which I view as a failed policy," she said.
However, H. Russell Frisby Jr., a Washington attorney who served on the Public Service Commission when deregulation was being considered in Maryland, said the concerns raised by O'Malley and the PSC are alarming. He said the commission tried to prevent conflicts of interest by establishing regulatory firewalls between Constellation and BGE. At the time, the commission's concerns extended to whether BGE and Constellation officials used the same bathrooms.
"I thought we had put restrictions on that sort of thing," Frisby said of Collins' work for BGE. "To find out it was still going on was disturbing."
Constellation contends that it complies with all state regulations and that there is nothing improper in the interactions of its corporate officers.
But Frisby and other legal experts say the PSC could solve the problem with stricter regulations and better oversight. Trying to force a breakup of the company could lead to a costly legal battle with an uncertain outcome, he said. Any costs associated with the effort probably would fall to ratepayers.
Strategic options
Such problems could be avoided if Constellation moves on its own to sell BGE. Under that scenario, the PSC could require that any cost savings from a sale be passed on to consumers, potentially resulting in a small rate reduction.
In an October conference call with analysts, Constellation Energy President and CEO Mayo A. Shattuck III said it was premature to comment on whether the company would consider spinning off or selling BGE, saying it needed time to see how Maryland's political and regulatory climate played out after the rate dispute. But he said the company would consider all strategic options.
"BGE is a very solid franchise," he said. "I'm sure that we'll be very thoughtful about how integrated it is or how important it is as an integrated part of this company as we look at all our strategic options going forward."
Some analysts said they would not be surprised if a deal occurred, especially given the political atmosphere in Maryland and the concerns raised by regulators.
"I don't think that I would rule out any avenue in terms of what management would be willing to pursue," Fremont said.
Analysts said there are a limited number of companies that might be interested in BGE. Some say Greensburg, Pa.-based Allegheny Energy is a potential buyer, though the company declined to comment on such speculation this week.
Allegheny serves more than 1.5 million customers in four states, including some 237,780 in Maryland. Acquiring BGE would enable Allegheny to spread its costs over a much larger territory in Maryland. Analysts say the company has the financial means to buy BGE, which could be worth $2.4 billion to $2.8 billion, based on the premiums paid in recent utility deals.
However, Allegheny suffers some of the same complications as BGE's parent. Like Constellation, Allegheny owns unregulated power plants and regulated utilities, leaving it open to similar criticism about conflicts of interest. However, most of its power plants are in West Virginia and Pennsylvania, which makes it a smaller player in Maryland's energy market than Constellation.
Analysts question whether Allegheny would be interested in BGE, since its focus in recent years has been on the fast-growing, unregulated parts of its business. BGE has reported flat to slightly lower earnings in recent years.
"I would be surprised if they'd be looking to make an acquisition of a quote, unquote 'boring' regulated utility," said Kalton. "That being said, at the right price anything is possible."
Alternatively, Constellation could choose to spin off BGE as it tried to do in 2001. The plan then was to free Constellation to pursue profits in the high-flying wholesale power business. But interest in the deal waned as profits in the power generating business fell precipitously, forcing some energy companies to write down the value of their plants or declare bankruptcy.
Today, wholesale energy suppliers and traders face the opposite situation. Profits are soaring, and Wall Street has sent shares of Constellation and other energy companies higher in recent months. Constellation reported a 70 percent gain in first-quarter profits this year. It has consistently beat analysts' earnings expectations, making investors more likely to support it as a stand-alone company than in the past.
Kalton said political pressure could force the issue, and not just in Maryland. He sees companies in other states being confronted with similar pressures to split.
"I think over the long term, those businesses will be split up," he said.
paul.adams@baltsun.com