Avista Management Takes Heat For Losses, Poor Market Planning
Unprecedented sustained peaks in electricity prices throughout the Pacific
Northwest and California in May and June, compounded by wholesale trading
mistakes made in mid-April, contributed to "significant losses"
in the second quarter for Avista Corp.'s regulated utility operations,
the company revealed last week.
Officials with the Spokane, WA firm admitted to making some mistakes,
but also attributed the setbacks to plain old bad luck --- at least for
its utility side of the business. Avista Utilities, the company's regulated
utility operation, is expected to spend nearly 25% more for purchased power
this year because of sustained price peaks, causing it to lose more than
$90 million in gross margin in the second quarter. If current pricing levels
are sustained through this year, the company expects that there could be
"additional potential losses of at least $50 million in gross margin."
Based upon the news last week, Fitch on Friday lowered the credit ratings
of the former high flying company, which had earned the respect of many
investors, including its Washington neighbor, Microsoft's Bill Gates, who
bought a 5% stake in the company in January (see NGI,
Jan. 24). Fitch lowered the ratings by one notch, reflecting "weakening
financial ratios and increasing business risk at the regulated utility."
Securities affected by the new rating including first mortgage bonds and
secured medium-term notes (MTNs) to BBB+ from A-; debentures and secured
MTNs to BBB from BBB+; preferred stock, trust originated preferred securities
and capital securities from BBB to BBB-. The short-term commercial paper
rating was affirmed at F2, and the Rating Outlook is Stable.
Despite the quick setbacks for the utility business, Avista CFO Jon
E. Eliassen said he expects the company overall to break even by the end
of the year. The problems are not related to the entire company, just the
utility side. In fact, officials said that its unregulated businesses,
which include Avista Energy, are doing well.
"Last year, we purchased $540 million worth of power," Eliassen
said. "When you look at the cost this year, we're buying about the
same amount, but there's been about a 25% total increase in the costs this
year. That's about a $40 million increase, two-thirds of which is in the
Eliassen, who has worked at Avista since 1970, said that the fundamentals
of power pricing in the Northwest "have changed forever." He
called the situation "unique," and said that pricing had changed
more rapidly than the company could have anticipated.
"Our weather forecasts have been accurate. Our stream flows and
snowpack forecasts were accurate. They turned out to be dead on, including
our forecasts for temperatures so far this year. But forecasts for power
pricing went out the window, and may be gone forever," he said. "This
is a difficult situation, but we are taking steps to immediately address
it. Our reputation is at stake and we take our responsibilities very seriously
to uphold and build on the strengths of this company. It has our full,
T. M. "Tom" Matthews, CEO, was upbeat during an investor conference
call last week, and said Avista Utilities will be continuing to move its
business strategy toward focusing on the power production side. He also
said the company will protect itself from exposures to price changes because
it will have more control over its power generation beginning in 2001.
The company and Cogentrix Energy are building a 270 MW natural gas fired
combined-cycle electric generating facility in Rathdrum, ID, that is expected
to begin delivering electricity in mid-2001. It also has formed a joint
venture with STEAG AG, Germany's largest independent power producer, to
develop, build and/or buy electric generation assets throughout North America
(see NGI, May 10, 1999).
What will help bring Avista Corp. to a break-even point by the end of
this year is the positive earnings of Avista Energy, which is expected
to earn an estimated $70 million or more in gross margins in the second
quarter, reflecting current results and mark-to-market value of its contracts.
While the company also gained on the May 4 sale of its minority interest
in a coal-fired generating unit in Centralia, WA, it lost in its short
position because its system capacity was reduced by 175 MW. Avista had
already decided to sell the plant because it needed to be upgraded to offset
environmental problems. However, the sale proved to be bad timing.
Because of lower power pricing at the time of the sale and historical
trends, Avista Utilities did not seek to cover May and June of this year
with firm commitments, and not covering the short position "was a
mistake," said officials. Energy that last year was selling for $19-$26
a megawatt is selling now in the Northwest for $100-$120 a megawatt, said
"We believe the electric energy markets in the Northwest are fundamentally
changing," said Avista Utilities President Edward Turner. "Based
on historical trends, our Avista Utilities second-quarter business plan
had forecast on-peak power prices at $19 levels. In recent weeks, Avista's
on-peak power costs averaged $60 per megawatt in May and over $100 per
megawatt in June, with spikes as high as $750 per megawatt. Prices are
at an unprecedented level, the likes of which have never been seen in the
Pacific Northwest, without any apparent relationship to actual costs of
However, it hasn't just been the price spikes that have sent Avista
Utilities on a spiral. In mid-April, an energy trader exceeded company
guidelines and entered into excessive levels of short-term, fixed-price
contracts for wholesale sales for delivery of power through October 2000,
without making matching purchases at the time. Matthews, who said he did
not find out about the problems until mid-May, said that the trader's manager
realized what was happening with the wholesale short-term contracts and
told the senior energy trader, Roger W. Scholten, to stop, but instead,
he ignored management, and sold more. That happened April 14, and Scholten
killed himself the following day at his Post Falls, WA home, according
to the Coeur d'Alene Memorial Funeral Home.
An audit the following week revealed what Scholten had done, and according
to the Matthews, the damage initially was less than $15 million. However,
the damage grew when the company decided to reduce its exposure to the
poor trades gradually. In a case of incredibly poor timing, Matthews said
that when senior management discovered the short positions, it decided
that based on historical pricing data, that the most prudent course was
to gradually diminish its position. But as market prices rose, it hurt
the utility business more than was anticipated.
When asked about risk management in the future, Matthews said that Avista
Corp. would have "ultimate control" over this ever happening
again by not ever doing that type of business.
"In the future, Avista Utilities will eliminate all trading activity
not related to optimizing its resources," he said. He declined any
comment when asked if the company would pursue any litigation against Scholten's
estate related to the extensive losses. However, one company official said
it was a possibility.
Matthews was upbeat about Avista's future, however. "We are taking
extensive measures to address our power cost issues, minimize our risk
and mitigate our utility's financial hardship." He said Avista Corp.
was beginning company-wide administrative expense reductions, cutting back
its utility capital expenditures and "aggressively" reviewing
alternatives to add generation. By Friday, the company plans to file a
request with the State of Washington for an accounting order to permit
the utility to recover its "extraordinary power costs associated with
utility retail operations."
"We believe we are addressing all of the near-term issues facing
the utility and we remain confidently focused on Avista's strategies for
value creation and growth," Matthews said.
Carolyn Davis, Houston