Public Service Enterprise Group (PSEG), New Jersey’s giant utility, has become the latest major U.S. power company to seek an exit from the competitive generation business.
In a statement attached to the company’s second-quarter 2020 earnings results released on July 31, Ralph Izzo, PSEG chairman, president, and CEO, said the company is “exploring strategic alternatives” for non-nuclear generating assets—which includes more than 6,750 MW—owned by the company’s competitive arm, PSEG Power.
The effort could “reduce overall business risk and earnings volatility,” improve PSEG’s corporate credit profile, and enhance its environmental, social, and governance (ESG) position, which is being driven by pending clean energy investments, methane reduction, and zero-carbon generation, Izzo said. “Our intent is to accelerate the transformation of PSEG into a primarily regulated electric and gas utility—a plan we have been executing successfully for over a decade.”
The future of PSEG would be focused on advancing its business as a “sustainable, customer-focused provider of essential electricity and natural gas services delivered by a regulated utility and contracted business,” Izzo said.
However, PSEG is still in the “preliminary stage” of its evaluation of how the company will fare without its non-nuclear merchant fleet. For now, it expects to launch “the marketing of a potential transaction in one or a series of steps,” in the fourth quarter of this year. It will then complete the effort “sometime in 2021,” he said.
PSEG also appears to suggest that the change won’t have much effect on certain financial aspects or business-as-usual for its other undertakings. “Given the relatively small part of PSEG that the non-nuclear business represents,” the decision would not have an impact on the company’s current shareholder dividend policy, it said. “PSEG will manage this process taking into account the interests of its diverse stakeholders, including our 13,000 valued employees. Any decision regarding the non-nuclear assets will not impact PSE&G or PSEG Long Island customers, operations or tariffs and would be subject to customary regulatory approvals.”
PSEG Joins String of Major Power Generators
PSEG’s proposed exit comes on the heels of a similar announcement by Dominion Energy earlier in July. The Richmond, Virginia-headquartered utility moved to sell the bulk of its gas transmission and storage assets for $9.7 billion to Berkshire Hathaway Energy, as well as to cancel the $8 billion Atlantic Coast Pipeline project it was developing with Duke Energy. Dominion said these actions will accelerate its transformation into a “pure-play” power company with zero-carbon generating assets that are anchored in regulated markets.
Thomas F. Farrell, II, Dominion Energy’s chairman, president, and CEO, said the divestiture is in line with several steps the company has taken since 2007 to “increase materially the state-regulated nature of our state-regulated nature of our profile, enhance the customer experience, strengthen our balance sheet, and improve transparency and predictability.” Efforts include “exiting oil and gas production and merchant fossil generation to merging with Questar and SCANA to embracing solar power, advanced storage and grid modernization, to relicensing our nuclear fleet, as well as the development of the largest offshore wind farm in the America,” he said.
Farrell told analysts in an earnings call on July 31 that the “strategic repositioning” to narrow its focus on regulated utility operations would account for about 85% to 90% of its operating earnings. As well as helping to reduce its overall business risk profile, it would give the company a “clear path to net zero by 2050,” he said. And that, in turn, would help the company target prospective shareholders, for whom ESG-related factors “are playing an increasingly prominent role in investment decisions,” he said.
Like PSEG, Dominion’s efforts echo similar strategies pursued by several other major power companies over the past five years to guard against distress in unregulated markets. These include Duke Energy, American Electric Power, and AES Corp. A more recent example of a high-profile business separation was the bankruptcy of FirstEnergy Corp.’s competitive arm FirstEnergy Solutions, which has now re-emerged as an independent firm, Energy Harbor Corp.
The Return to Regulation Explained
But PSEG’s pursued transformation into a primarily regulated company is also interesting owing to the company’s history. The Newark-headquartered company, which was incorporated under New Jersey laws in 1985, owns two direct wholly owned subsidiaries: PSE&G and PSEG Power.
PSE&G, which was founded in 1924, is PSEG’s electric and gas transmission and distribution arm. It earns its revenues through regulated rate tariffs, as well as through investments in regulated solar power projects and energy efficiency programs in New Jersey, overseen by the Board of Public Utilities (NJBPU). PSE&G serves about 6.2 million, or about 70% of New Jersey’s population.
PSEG Power, on the other hand was founded as a Delaware limited liability company in 1999 after New Jersey embarked on its landmark electricity deregulation and restructuring—an event frequently cited as a crucial driver that led to the dramatic transformation of the state’s energy landscape. PSEG Power owns the company’s merchant fleet, which competes primarily in the PJM, ISO-New England, and New York ISO wholesale electric markets.
The company’s total generation in 2019 was 56.8 TWh: 56% was produced by gas, 34% nuclear, 3% coal, 5% oil, and 2% pumped storage. In total, PSEG Power’s non-nuclear fleet includes more than 6,750 MW of fossil generation in New Jersey, Connecticut, New York, and Maryland. The fossil fleet comprises about 5.1 GW of combined cycle gas turbines, about 1.2 GW of combustion turbines, and a 450-MW peaking plant. PSEG Power also earns revenues from 479 MW of solar generating facilities in 17 states under long-term sales contracts for power and environmental products.
Why PSEG Will Hang on to Merchant Nuclear Assets
PSEG Power’s nuclear fleet, meanwhile, includes its wholly owned 1,240-MW single-unit Hope Creek plant and the two-unit 2,486-MW Salem plant in New Jersey, which it operates but co-owns with Exelon. It also co-owns (with Exelon) the two-unit 2,549-MW Peach Bottom plant in Pennsylvania. In April 2019, PSEG won zero-emission certificates (ZECs) from the BPU for its Salem 1, Salem 2, and Hope Creek nuclear plants.
The company expects to receive ZEC revenue of about $10/MWh from the units for about three years through May 2022 from New Jersey’s electric distribution companies (EDCs) in New Jersey. PSEG highlighted steady earnings from the plants it its most recent 10-Q filing, noting that the addition of ZECs to second-quarter results added $0.02 per share. The company also revealed it is mulling applying for ZECs for the period spanning 2022 to 2025. Applications are due in fall 2020 and an NJBPU decision to approve them is likely in April 2021.
But on Friday, Izzo also painted the nuclear fleet as a “necessary component” in enabling New Jersey to meet its state’s goal to produce 100% of its power from carbon neutral sources by 2050, as outlined in the NJBPU’s Master Plan this January. He said the nuclear plants produce more than 90% of the state’s zero-carbon power. “As we begin the second round of the ZEC program by filing our applications this fall, it’s important to note that the financial need for ZECs is more critical than ever,” he said.
Continued ZECs were necessary because forward prices in PJM Interconnection have declined from where they were just two years ago, from $30/MWh to $25/MWh, Izzo said. “ZEC payments compensate nuclear generation for the zero carbon attributes that are otherwise unrecognized by the wholesale markets and are an essential component to the economic viability of the New Jersey nuclear fleet,” he said.
However, asked whether the company had contemplated divesting its competitive nuclear fleet, Izzo responded: “I wouldn’t want to say the word ‘never,’ but we are not marketing those nuclear plants. We have every intention and expectation of holding on to them,” he said. Divesting the fossil fleet presented a better opportunity for now, he suggested: “I just think that the candidate pool for purchasing is vastly, vastly larger for the fossil assets.”
An Emphasis on De-Risking
Still, as with Dominion and other power companies which have pursued competitive market exits, risk reduction appears to be the most compelling driver for the strategy.
Izzo said on Friday the strategy was designed to “remove that earnings volatility and have people explicitly recognize the valuation that PSE&G deserves.” The move was necessary, even though PSEG showed an overall profit for the second quarter this year, he said.
The company reported net income of $282 million for PSE&G—a $56 million improvement over the same period last year—and $170 million for PSEG Power, $210 million more than the second quarter of 2019, even though total generation output declined by 3% owing to impacts from the COVID-19 pandemic.
PSEG noted that while PSEG Power’s fuel diversity helped “mitigate risks associated with fuel price volatility and market demand cycles,” the company has retired or sold more than 2.4 GW of coal generation since 2017. In September 2019, it competed the sale of its 776-MW ownership interests in the Keystone and Conemaugh generation plants in western Pennsylvania, and more recently, it announced the early retirement of its 383-MW coal unit in Bridgeport, Connecticut, in 2021.
But PSEG has also highlighted the myriad competitive market risks it faces “New additions of lower-cost or more efficient generation capacity, as well as subsidized generation capacity, could make our plants less economic in the future,” it says in its previous 10-Q. These issues are compounded by competitive pressure due to demand-side management and other efficiency efforts, which have resulted in reduced load requirements. Recent measures to allow demand response and capacity imports to bid into capacity markets have also affected prices paid to generators in competitive markets. Finally, “It is also possible that advances in technology, such as distributed generation and micro grids, will reduce the cost of alternative methods of producing electricity to a level that is competitive with that of most central station electric production,” it said.
Asked on Friday why PSEG was moving to sell its 479-MW solar fleet though it is seeking to boost its ESG scores, Izzo pointed to the size and location of its solar assets. “I think the biggest project is like 40 or 50 MW and most of them are 5 and 6 [MW]. They are spread around 17 states. So the scale is what we’d like it to be and candidly, we’d like to focus more of our green and carbon free attributes in the Mid-Atlantic region and as it relates to particularly nuclear and potentially offshore wind,” he said.
“We don’t think we were getting proper credit for it in our own valuation. It’s almost never picked up—you put an EBITDA multiple on something that’s largely benefiting from investment tax credits and that doesn’t get reflected in the stock price in a way that it might provide greater value to somebody who has a different calculus around it and know how to measure economic value,” he said.
PSEG will instead focus its efforts on a number of investment priorities” that are aligned with New Jersey’s clean energy agenda, he said. “We are on-track to execute on our five-year, $12 billion to $16 billion capital plan without the need to issue new equity, and our net liquidity position at June 30 remains ample at $4 billion,” Izzo noted.
Though PSEG is continuing energy efficiency settlement discussions following the NJBPU’s adoption of the energy efficiency framework, the company plans to extend investments in existing programs by $111 million. Also ongoing is PSEG’s “due diligence and negotiations” toward a joint venture agreement to potentially acquire a 25% interest in Ørsted’s 1,100 MW Ocean Wind project.
While PSEG expects to make an investment decision about the offshore wind project later this year, Izzo expressed enthusiasm for the state’s November 2019–announced target to install 7.5 GW of offshore wind by 2030. New Jersey has begun discussions about Round 2 solicitations, which will secure 3.5 GW of offshore wind, he noted. “So this is becoming more and more real with every day and I have no reason to not believe that the state’s full aspirations of 7,500 MW as well as New York state’s 9,000 MW, and so on on the list won’t be realized.”
Encouraging Market Signals
Responding to a question about why this was the right time to pursue the transition, Izzo explained that while PSEG had long-expected the regulated and non-regulated businesses would eventually separate, “sustained discount and valuation” indicated “investors were not satisfied with an integrated model.”
The company is also acting on market signals. This May, FERC issued a revised order establishing a new return on equity (ROE) policy for reviewing existing transmission ROEs to determine if they are unjust and unreasonable. PSEG is engaged in settlement discussions with the NJBPU and the New Jersey Division of Rate Counsel about the level of PSE&G’s base transmission ROE. An adverse change—a 25 basis point reduction—could dent annual net income by $15 million, it says.
“We’ve been very public about our discussions on transmission ROE, so that’s a driver—unknown yet, but not a big unknown and we have good news coming out of the FERC [Minimum Offer Price Rule (MOPR)] in terms of our nuclear plants being able to bid basically zero and clear that market,” Izzo said. “So the remaining pieces that discount associated with having the integrated model and you can’t put our current valuation all on the back of transmission ROE.”
New Jersey’s consideration of a fixed resource requirement (FRR)—a mechanism that PSEG and Exelon have urged the state to adopt because they argue that it is one way to help the state to meet its 100% clean energy goals under the federally approved MOPR—is a “totally independent process” being driven by the NJBPU, Izzo said.
“I think the state is still trying to figure out: Do they want FRR that simply secures the carbon-free energy, because they want to do an FRR that secures all of their energy? I don’t see that being any way shape or form influenced by our decision to divest of our fossil assets,” he said. “In terms of legislation, that’s a purely a function of what kind of FRR they design,” he said, adding: “It’s just too early in the FRR discussions to be definitive.”