Ann de Rouffignac
OGJ Online
Harvey Padewer, group president Duke Energy Services, says convergence of the natural gas and power industries is still a thriving concept, despite uncertainty about electric deregulation and high prices for gas and power.
�Anyone who says that convergence is dead is asleep. They need to be slapped awake,� Padewer says.
Convergence, certainly not a new concept within the energy industry, is the process of combining the electric and gas sides of the energy business.
Duke Energy, a unit of Duke Energy Corp., is a prime example of convergence. It delivers electricity and natural gas. It gathers, processes, and stores natural gas. And it develops, constructs, and operates power plants.
Tying it all together, Duke has a large energy trading and marketing arm which trades energy-related commodities, including gas and electricity, around the globe. This energy intensive strategy has been kind to the big Charlotte, NC-based company. In 1999, Duke earned $1.5 billion, or $4.08/share, on revenue of $21.7 billion. Income increased by 20% in 1999, compared to the year before.
The company reported a rise to $766 million in 2000 third quarter net income (including a one-time gain on the sale of the company's interest in BellSouth Carolina), up from $436 million in 1999 third quarter. Revenue for the 2000 third quarter rose 135% to $15.7 billion.
Duke not only touts convergence, it has embraced the old-fashioned strategy of vertical integration among energy companies. Padewer, who joined Duke in January 1999, says vertical integration along energy product lines is still a valid strategy.
Energy companies should leverage what they do best, he explains.
�We are damn good engineers, energy traders, marketers, and project developers,� he says. �We are trying to vertically integrate and build power plants around our own pipelines or where there are several other connecting pipelines.�
Growing horizontally
Padewer says merchant generators will, however, have to grow horizontally and get bigger as the industry consolidates and deregulates. He doesn�t think the 6,000 US electricity companies will last long in this environment.
�Over the long haul generators will need at least 50,000 Mw to be a player in the market,� he said.
Separate from its regulated portfolio of generating assets, Duke has 6,200 Mw in operation, 3,300 Mw under construction, and 12,500 Mw in advanced development. Eventually, it hopes to have access to or own the 19,000 Mw on the regulated utility side of its business.
Unlike some large energy companies -- most notably Enron Corp. and Williams -- Duke has not committed significant resources to nonenergy endeavors. Some energy companies have delved into real estate services, water, communications, and high tech activities such trading bandwidth.
�The jury is still out on bandwidth,� says Padewer. �No one knows for how long.�
Duke, meanwhile, is sticking with a broad-based energy strategy, including investing in byproducts such as fertilizer or ammonia, Padewer says.
�As long as you have buyers and sellers of an energy-derived product, that will create a market,� he says.
The company looked for ways to exploit exploding natural gas prices. But what came into focus is the potential harm high gas prices can inflict on chemicals that require inputs derived from natural gas.
�Gas prices may be astronomical in the US. But they are about 25�/mcf in Trinidad. So we looked to becoming a partner in an ammonia plant in Trinidad,� he says.
Padewer says Duke strives to hold a balanced portfolio of assets across regions, time, and commodities.
�We analyze each market and each commodity in each market,� he says.
Whether Duke is long or short on generation assets in a given market depends on the situation. Padewar says the company doesn�t advocate an �asset light� strategy or a �buy and hold� strategy either. Under a balanced portfolio approach, Duke's holdings may differ radically from market to market and from time to time. But this market by market approach does not negate the company's fundamental belief that trading and assets are linked.
One trip ponies
�Companies that don�t have both capabilities are one trip ponies,� Padewar says.
Prior to joining the unregulated arm of Duke, Padewer was president of Aquila Energy, the gas and power marketing and risk management arm of UtiliCorp United Inc. UtiliCorp is looking for a generation partner for Aquila and in December said it will spin off a portion of Aquila in an initial public offering to the public. Padewer knew what it was like to have few physical assets to trade around.
It�s hard to sell �naked� options, he says. With few assets to back up trading activity, the risk profile has to be raised higher and higher to increase profits, Padewar explains.
In California, for example, Duke�s balanced portfolio and market-by-market approach means the company will maintain a long position in power generation because electricity demand is growing and prices have been rising. In Europe, where prices are falling, Duke doesn�t hold or buy physical assets.
In the Midwest, Duke sold pipelines that transport gas to Chicago because in the company's judgment too many pipes are serving that area, he says. Duke also recently announced the sale of its 23% interest in a 500 Mw merchant power plant in Oklahoma.
�We are not a project oriented company. We build a business,� Padewer says.
Duke goes into an area, evaluates assets, and the market. The company begins by building a business centered, perhaps, on a pipeline in the area. Duke then �layers in� core businesses such as gas transportation and trading, marketing, and even power generation, a strategy that creates a business with staying power, Padewar says.
Duke is bullish about the US electricity market. Padewer predicts the US will need an additional 200,000 Mw over the next 10 years.
He says the company isn't worried that a recession might derail this optimistic forecast. Even with a slowdown, the telecommunications and high tech industries will continue to boost demand for power.
In California, the problem can be solved with more power plants, says Padewer, but the political will is not there. He suggested a unique solution to the lengthy and often unsuccessful efforts by companies to site power plants in California.
Sites should be selected through a lottery system where the best locations are thrown into the hat and chosen at random by officials, Padewar says. By shortening the permitting process, he predicts the problem in California could be over within 24 months.
�But politicians like to paint us (the merchant generators) as the bad guys,� says Padewer. �When the lights go out and they can no longer cook their food, then the political will to solve the problem will emerge.�