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Avista Management Takes Heat For Losses, Poor Market Planning

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 second quarter."

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, 100% attention."

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 Matthews.

"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 generation."

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

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