Partner's Expertise Featured at Energy Roundtable

February 28, 2006

Energy Roundtable Discussion, hosted by Texas Lawyer

Summary of Comments by Dan Watkiss, partner

TOPIC: What keeps clients up at night

WATKISS: In the 1990s and leading up to the energy crisis of 2000-01, there was a proliferation of exotic trading devices, but that's not the world we live in now. Clients are concerned about understanding their obligations under the strict anti-fraud and marketing manipulation laws that govern natural gas transactions, particularly with new entrants into the energy business, which are predominantly banks and X funds.

Under these laws, the more compliance programs companies have in place, the more likely they will be to get mitigation on penalties if they do something wrong. Therefore, companies are developing in-house compliance programs as a safe harbor against onerous penalties and to prevent prosecution of their companies because of the misdeeds of employees. It?s critical to have in place a comprehensive compliance program.

TOPIC: The role of nuclear power

WATKISS: A lot of research and development money in the Energy Policy Act is focused on nuclear energy. For the first time in 30 years, we're on the cusp of a very big expansion in nuclear energy. Investors are circling back in response to the turmoil in the energy markets in 2000-01. The philosophy of a lot of people in the power business is back to basics. That business model worked for awhile because basic utilities prosper with zero inflation and low interest rates, but with the high rates we see today, I don?t see that model working. That will spur a lot of investments in collateral business lines.

TOPIC: Alternative energy sources

WATKISS: My law firm does an energy blog that covers new developments. It's amazing how many states in the last two years have adopted portfolio standards requiring you to include different types of fuels, a lot of which are renewables. The Energy Policy Act rejected portfolio standards, but states have been more aggressive. Do you have a sense of how hard that will drive renewables, particularly in light of the governor of New Mexico New Mexico This could support wind farmers who sell power to California.

issuing state bonds to fund transmission upgrades in

TOPIC:  Comparing the economics of nuclear and electric power plant construction and operation

WATKISS:  In the 1950s and early 1960s, nuclear power sold to the public was too cheap even to meter. Capital costs were high, but then going-forward costs were small. One reason nuclear became more expensive was gross mismanagement (in construction), which gave nuclear a bad name from an economic point of view. As coal gasification increases, we're seeing coal prices go up, so costs of natural gas and coal are increasing, which will improve the economic forecast of nuclear.

TOPIC:  Transmission lines

WATKISS:  A number of issues in the Energy Policy Act are intended to address transmission needs, but will they work? Transmission lines are ugly, so no one wants them. You can have tax incentives, but what if you can't get the political will to condemn the rights of way to build transmission lines?

The Energy Policy Act authorizes federal agencies to work in concert to develop needs corridors to relieve severe congestion in the power grid. Once a needs designation has been conferred on an area, it becomes federal eminent domain. Whether that will be used and can overcome local opposition is a good question, but it creates the opportunity to have federal eminent domain. Also, there is a provision that if a state doesn?t act within a reasonable time to get a right of way, the feds can step in.

In response to the 1992 Energy Policy Act, when the Federal Energy Regulatory Commission adopted open access to the transmission grid, some states challenged the order and went to the Supreme Court, which affirmed it. A brief submitted by a group of physicists and electrical engineers said if there is any one industry that has a commodity that cannot recognize state boundaries, it is the grid, so if it?s not federal, it won't happen.

TOPIC:  Whether the federal government should decide where transmission lines should go

WATKISS:  There has always been federal eminent domain under the Natural Gas Act. This has been used in a way that has not increased federal involvement.

TOPIC:  Challenges to energy construction projects from local opposition

WATKISS:  We have developed facilities off Maine that have gotten slam-dunked with not in my backyard opposition. It's also hard to site wind projects offshore.

An emerging issue is the thermal and fractionation qualities of LNG versus domestic gas. The different acidities of regasified LNG strain the seals on pipes. Gas-fired facility specifications cannot be exceeded or they will lose their warrantee. We're starting to see litigation.

TOPIC: The next bad behavior FERC will look for

WATKISS:  One area I've seen a lot of attention to is where you have a financial position in the market that will pay off better if you also have a physical transaction. But, trading companies are barred from actions that lack legitimate purposes. New anti-fraud provisions are even more stringent. If you're trying to maximize your financial position by taking a loss on a physical transaction, someone will challenge you. A lot of my clients prevent this by making sure the desk that trades physicals does not trade financials.

As a result of the Energy Policy Act, there have been significant increased civil and criminal penalties for market manipulation. FERC made it clear that penalties will be less severe if a company has a good compliance program with detailed written documentation and buy-in from senior management. Anyone who is a purchaser or seller gets trained.

For one client, we devised a best-in-class program; we worked with an accounting firm to decide how to comply.

We saw the spectrum from too detailed to it's company policy to be honest. The most helpful were detailed enough to have some good information and semiannually worked through things that cross the line.

TOPIC: New trends

WATKISS: First, the country will adopt a carbon emissions cap which will change the use of carbons. Second, there will be a provision that says the state public utility commissions must adopt time of use standards. A 4-percent reduction in use during peak hours in California reduced the price 200 percent. Utilities must consider time of use?pricing. If adopted, the retail electricity providers must supply customers with time of use meters. This will take off slowly but will be adopted over time, especially with the development of smart meters.