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Morgan Stanley sees 'low probability of success' of FirstEnergy's rider plan


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Morgan Stanley sees 'low probability of success' of FirstEnergy's rider plan

MorganStanley Research contends FirstEnergyCorp.'s latest plan to subsidize generation in Ohio faces a "lowprobability" of securing FERC approval and faces a "real risk ofrejection/modification at the state level."

"Webelieve FERC is likely to rule that the revised 'rate mechanism' is insubstance an impermissible affiliate transaction," Morgan Stanley analystStephen Byrd wrote in a May 6 report.

FirstEnergy'sOhio utilities filed a petition for rehearing May 2 with the Public UtilitiesCommission of Ohio in which they asked regulators to approve to their generation riderwhile eliminating their recentlyapproved power purchase agreement with

Theplan is designed to act as a hedge on 3,200 MW of previously rate-basedgeneration, but would not be based on actual plant costs and the utilities willno longer buy the power and sell the output into the market.

Therevisions were made on the heels of FERC'sdecision to revoke waivers of affiliate power sales restrictions itpreviously granted to the utilities and FES, as well as subsidiaries.

FirstEnergysaid that its plan would no longer be specifically tied to the performance ofthe 2,210-MW W.H. Sammiscoal plant, 908-MW Davis-Bessenuclear plant or its interests in OhioValley Electric Corp.'s Kyger Creek and Clifty Creek coal plants. Under the new proposal,customers will still receive rate credits or charges to offset market costs.

Acompany spokesman said since the revised plan "strictly involvesadjustments to retail rates," it would be under PUCO, not FERC,jurisdiction.

Byrdsaid "it is likely" that the Electric Power Supply Association, whichfiled a complaintwith FERC over the prior PPA plan, will file a complaint tied to the proposedhedge and seek an injunction "that would stay [FirstEnergy's] ability tocollect revenues under the hedge until the review of the hedge by FERC iscomplete."

Theanalyst noted the scope of what FERC can consider when policing affiliatetransactions is "broad" and is likely to encompass FirstEnergy'sproposed hedge.

Inaddition, "the hedge arrangement is sized precisely to the projectedoutput and costs of the Sammis and Davis-Besse plants, and [is] therefore linkedto those plants," Byrd wrote.

Themost recent filing also includes a provision that would allow PUCO to reducethe charge/credit of the rider in the event that during the eight-year term ofthe plan, less than 3,200 MW of formerly rate-based nuclear or fossilgeneration in PJM's ATSI transmission zone remains in operation.

Theanalyst said this provision is tied to the company's merchant power fleet,which is another reason FERC may reject the arrangement.

"[W]hile[FirstEnergy's] utilities are not permitted to send the cash flow received fromcustomers under this hedge to [FirstEnergy's] merchant affiliate, the utilitiesare permitted to send the cash to [the parent company], and at that point, all[FirstEnergy] cash is fungible," he wrote.

MorganStanley notes that PUCO approval of the revised plan also is not a given,especially since there is now no guarantee that the hedge payments made bycustomers will keep Sammis and Davis-Besse online.

Morgan Stanley also projected the total payments from customers will exceedmarket prices by approximately $4.3 billion over the eight-year term ofFirstEnergy's electric security plan.

"[W]ebelieve PUCO will not accept [FirstEnergy's] proposal that its Ohio utilitiesbe able to exclude revenues from this hedge arrangement … in the calculationsunder the Significantly Excessive Earnings Test (SEET) relating to theseutilities' earned ROEs," Byrd wrote.

MorganStanley reduced its price target on FirstEnergy to $36 from $41 on theassumption of no PPA, rider or re-regulation in Ohio.

Some support

OtherWall Street analysts have had a more favorable view of FirstEnergy's ratemechanism.

"Whileit is to be determined whether the latest modification will be confirmed,[FirstEnergy] appears to have navigated the pitfalls in the previous order andincreases the probability of success," UBS Securities LLC analyst JulienDumoulin-Smith wrote in a May 2 report.

JefferiesLLC analyst Anthony Crowdell wrote in a May 3 report that the revenue from thisplan "could help improve the parent credit ratios and minimize equityneeds, but we would need some time to see if the PUCO will be supportive."

WallStreet has said that FirstEnergy would need to issue approximately $2 billionin equity to support its balance sheet and credit metrics absent a generationrider.

FirstEnergymaintains that customers will receive $561 million in total credits over theeight-year term of the ESP, under which distribution rates will remain frozen.The company also will keep in place the risk sharing mechanism, gridmodernization plan, CO2 reduction goal and energy efficiency commitmentsapproved in the original proposal.