III. The Proposed Change of Control
A. Overview--Parties to the Transaction
LGS, Western Hub and WHP, the Joint Applicants in this proceeding, seek Commission authorization for the transfer of control of Western Hub to WHP, and thereby, the indirect change of control of LGS, Western Hub's wholly owned subsidiary, as well as the Lodi Facility. On August 22, 2001, Western Hub, its owners, and WHP executed a Unit Purchase Agreement for the sale of Western Hub to WHP, subject to this Commission's approval. The transaction provides for cash consideration of $105 million plus up to $3 million in expenses.3 Joint Applicants assert that "the change in ownership at the holding company level will not result in the transfer of any certificates, assets, or customers of LGS, which will continue to be bound by the terms and conditions prescribed by the Commission in D.00-05-048." (Application at 2.)
At present, three limited partnerships (Haddington/Chase Energy Partners LP, Haddington Energy Partners LP and Haddington Energy Partners II LP) own all but approximately 1% of Western Hub; ten individuals own the remainder.4
WHP, a Delaware limited liability company with its principal place of business in Kansas City, Missouri, was formed expressly to acquire and own Western Hub. The Application identifies two, 50%-50% owners of WHP--Aquila WHP Storage, L.P. and ArcLight WHP, L.L.C., the former wholly owned by Aquila, Inc. and the latter, by ArcLight Energy Partners Fund I, L.P. (ArcLight). The Application proposes that WHP's two owners, through their respective subsidiaries, own and manage WHP on a 50-50 basis. Each will contribute up to $25 million in equity capital in return for common or preferred stock and each has designated two individuals to serve on WHP's four-member Management Committee.
The Application identifies Aquila, Inc., a Delaware corporation with principal offices in Kansas City, Missouri, as a major wholesale energy merchant in the United States and abroad and a subsidiary of UtiliCorp United Inc. (UtiliCorp), which owns various utility and other, unregulated businesses in the United States, Canada, Australia and New Zealand. 5
Subsequently, Joint Applicants filed a March 4, 2002 declaration of Jeffrey D. Ayers, General Counsel and Corporate Secretary of Aquila Merchant Services (AMS). Ayers' declaration states that UtiliCorp has successfully acquired all outstanding public shares of Aquila, Inc., has taken the name "Aquila, Inc." for itself, and that the former "Aquila, Inc." has been renamed AMS. The declaration states that the name change "did not result in any change in the business or operations or corporate structure of [AMS]".
To avoid confusion, hereafter we use the name "Aquila" to refer to the holding company formally known as UtiliCorp and we use the name "AMS" to refer to that holding company's subsidiary, formerly known as Aquila, Inc.
ArcLight, the other 50% equity investor in WHP, is a Delaware limited partnership with its principal place of business in Boston, Massachusetts. It is managed by ArcLight Capital Holdings, L.L.C., a Delaware limited liability company founded by former executives of John Hancock Life Insurance Company and the investment banking community. The company was formed to make private equity, equity-like and debt investments in regulated and unregulated public utilities and in other energy and telecommunications enterprises. According to the Application, John Hancock Life Insurance Company has committed to invest up to $500 million in ArcLight.
B. Discussion: Ramifications of the Change of Control
Pub. Util. Code § 854 requires Commission authorization before a company may "merge, acquire, or control...any public utility organized and doing business in this state...." The purpose of this and related sections is to enable the Commission, before any transfer of public utility authority is consummated, to review the situation and to take such action, as a condition of the transfer, as the public interest may require. (San Jose Water Corp./Company. (1916) 10 CRC 56.)
As outlined above, the instant Application presents a proposed, indirect change of control of LGS (the entity this Commission regulates) via the sale of its corporate parent, Western Hub, to WHP and through WHP, to AMS and ArcLight. Both Western Hub and LGS will continue as separate legal entities. Joint Applicants do not seek the transfer of LGS' CPCN; rather, LGS will continue to hold it and will continue to operate under the terms and conditions it imposes, pursuant to D.00-05-048, as modified by subsequent Commission decisions, including today's decision. We stress that unless and until modified, all terms and conditions D.00-05-048 mandates (e.g., a general liability policy of $1 million and umbrella policy in the amount of $50 million per occurrence) will continue to apply. Likewise, LGS will continue to operate in conformance with its tariff, filed with the Commission on July 13, 2001, and with any subsequent amendments of that tariff.
Thus, our primary concern in this proceeding is how the indirect change of control will affect LGS, its customers and the market place. Joint Applicants concede that AMS' holdings and business interests are significant in the aggregate. AMS owns or controls a geographically diverse portfolio of energy assets, trades commodities which include, among other things, electricity and natural gas, coal, weather derivatives, emission allowances and bandwidth capacity, and offers products and services which allow its clients, including regulated and unregulated public utilities, industrial companies and other wholesale energy merchants, to manage risks such as price volatility and supply availability. AMS has a client base in North America, the United Kingdom and Europe.
However, Joint Applicants state that at present AMS' activities do not constitute market power in California. They state that while AMS owns, controls or has under development some 4,100 megawatts (MW) of electric power generation capacity, the portion in California is limited to a minority, non-operating interest in four co-generation facilities and that this interest, in the aggregate, totals approximately 88 MW. AMS also owns the 21 Bcf Katy Storage Facility and Market Hub outside of Houston, Texas,6 in addition to 13 natural gas gathering systems, 1.6 Bcf/d of natural gas transportation capacity, approximately 30,000 barrels per day (Bbls/d) of natural gas processing capacity and a coal terminal capable of moving five million tons of coal annually. AMS also has a small amount of gas capacity into California under contract but it has no intrastate pipeline capacity or other natural gas facilities.
In their Response to the Assigned Commissioner's Ruling on Market Power, Joint Applicants submitted various analyses in support of their position, including a market assessment, but no market power study. Recently, in our review of the application of Wild Goose Storage, Inc. (Wild Goose), for approval of its proposed expansion project, we examined market power in the gas storage market in California and the western United States.7 The Commission found evidence of a highly concentrated market for storage injection and withdrawal in both the northern California and statewide California markets and a significant market share for Wild Goose. Though the Commission was unable to conclude definitively, on the record of that proceeding, "whether Wild Goose possesses and can exercise market power", the Commission imposed a number of reporting requirements and rescinded certain, other reporting relaxations, "to monitor the situation more fully in the future." (See Wild Goose Expansion, D.02-07-036, mimeo. at pp. 16-17 and Finding of Fact 12.) The Commission also prohibited Wild Goose from engaging in any storage or hub services transactions with its parent company or any affiliate owned or controlled by its parent.
The Lodi Facility has a smaller inventory capacity than Wild Goose (12 Bcf of working gas compared to 29 Bcf for the expanded Wild Goose facility) but the physical attributes of its storage reservoir permit highly flexible storage operations. The peak injection capacity at the Lodi Facility (400 MMcf/d) nearly matches Wild Goose (450 MMcf/d) and its peak withdrawal capacity is substantial (500 MMcf/d, compared to Wild Goose's 700 MMcf/d). Moreover, part of Wild Goose's peak withdrawal capacity (200 MMcf/d) moves through Line 167, the major transmission line into Sacramento; the remaining volumes (500 MMcf/d), associated with Wild Goose's expansion project, will compete directly with the Lodi Facility for transmission access to the Bay Area load center.
Considering these realities, we must question assertions that LGS does not have and cannot exercise market power in the gas storage market. The evidence Joint Applicants have presented is at best inconclusive; certainly, it does not permit us to find for LGS on this issue. Therefore, as a condition of the authorization of transfer of control (and continued market-based rate authority), we will impose the same reporting requirements we have imposed on Wild Goose. Specifically, we will prohibit LGS from engaging in any storage or hub services transactions with its ultimate parents, Aquila and ArcLight (or their successors) or any other affiliate owned or controlled by either of those entities. In addition, we will direct LGS to promptly inform the Commission of the following changes in status that would reflect a departure from the characteristics the Commission has relied upon in approving market-based pricing: LGS' own purchase of other natural gas facilities, transmission facilities, or substitutes for natural gas, like liquefied natural gas facilities; an increase in the storage capacity or in the interstate or intrastate transmission capacity held by affiliates of its parents or their successors; or merger or other acquisition involving affiliates of its parents, or their successors, and another entity that owns gas storage or transmission facilities or facilities that use natural gas as an input, such as electric generation.
We will also require LGS to provide the Commission with service agreements for short-term transactions (one year or less) within 30 days of the date of commencement of short-term service, to be followed by quarterly transaction summaries of specific sales. If LGS enters into multiple service agreements within a 30-day period, LGS may file these service agreements together so as to conserve the resources both of LGS and the Commission. The quarterly transactions summaries should list, for all tariffed services, the purchaser, the transaction period, the type of service (e.g., firm, interruptible, balancing, etc.), the rate, the applicable volume, whether there is an affiliate relationship between LGS and the customer, and the total charge to the customer. For long-term transactions (longer than one year), LGS should submit the actual, individual service agreement for each transaction within 30 days of the date of commencement of service. To ensure the clear identification of filings, and in order to facilitate the orderly maintenance of the Commission's records, long-term transaction service agreements should not be filed together with short-term transaction summaries.
All reports required by the preceding paragraphs should be provided to the Director of the Commission's Energy Division within 60 days of the effective date of this decision on an initial basis and thereafter, as specified above or by the applicable rule, General Order, or statute.
We turn next to other aspects of the proposed transfer of control, which we also must review against Joint Applicants' uncertain market power showing. Joint Applicants propose that AMS provide construction management services during the remainder of the construction project at the Lodi Facility, including a "turnkey wrap" of all construction arrangements.8 They also propose that AMS manage the ongoing, day-to-day operations of LGS and the Lodi Facility. Both management agreements are to be market-based and negotiated with ArcLight on behalf of LGS.
According to Joint Applicants, the banks involved in the debt financing transaction require that AMS assumes the turnkey wrap function, a typical requirement in project finance lending transactions. With respect to the proposal that AMS assume, under contract, the day-to-day management of ongoing operations for LGS and the Lodi Facility, Joint Applicants point out that AMS has expertise in the management and operation of an active gas storage facility (e.g., Katy Hub). They contend that this expertise, together with AMS' broad experience in other, related aspects of the natural gas industry should benefit LGS and its customers.
We do not question AMS' managerial expertise and ability to fulfill the obligations under these proposed contracts, including, most importantly, to ensure completion of unfinished construction at the Lodi Facility. From a practical standpoint, it appears highly desirable to have a single entity assume the turnkey wrap function, since none of the three main contractors involved in the project at present has that construction obligation. However, because the contracts would create an affiliate role in the management of LGS, we need to examine the proposal closely.
As noted above, Wild Goose Expansion imposes a ban on affiliate transactions with respect to any storage or hub services.9 Such services typically concern the movement and storage of natural gas for the owner of the gas, unlike the management contracts Joint Applicants propose for construction and day-to-day operations. Furthermore, the terms of these management contracts would be negotiated between the two equity owners, AMS and ArcLight, on behalf of LGS-a factor which should militate to curb the exercise of affiliate self-interest at the expense of LGS or its customers.
Wild Goose Expansion also lifts the stay on the Commission's review of whether the 1997 Affiliate Transaction Rules should apply to independent storage-and LGS, as well as Wild Goose, is a respondent to that proceeding, R.01-01-001.10 The regulatory propriety of such contracts necessarily will be at issue in the rulemaking. We will not prejudge the outcome of R.01-01-001 by exempting these contracts, or similar contracts, from consideration in that proceeding. Thus, because we believe it desirable to take steps to ensure that the change of control leaves LGS with able management over the remaining construction as well as day-to-day affairs, we will authorize the management contracts, on a provisional basis. We recognize that provisional approval may create more business risk than Joint Applicants are willing to assume, but that is a matter that they, alone, can decide.
A final, critical aspect of our consideration of whether to authorize the change of control is the financial standing of AMS and ArcLight. Both AMS (which Standard & Poor's and Moody's rate as investment grade11) and ArcLight bring substantial financial resources to the proposed transaction. As Joint Applicants explain in the Application, following issuance of D.00-12-026, LGS began the search that has lead to the proposal before us today:
... LGS' existing investors began exploring alternative sources of additional equity capital in order to complete construction of the Lodi Facility, as was clearly contemplated in D.00-12-006 (citation omitted). These efforts identified two potential sources of funding: financial investors who would find it attractive to purchase a passive minority interest in the Lodi Facility; and industry investors who are active in the energy business and would be interested only in acquiring a controlling interest in the Lodi Facility. Based on the financing term offered by various potential investors, Western Hub elected to enter into an interim financing transaction [authorized in D.01-08-023] and this transaction with WHP Acquisition. (Application at 12.)
Between them, AMS and ArcLight appear to bring sufficient managerial and financial expertise, as well as adequate financial resources, to oversee the successful operation of LGS and the Lodi Facility and to bring the remaining portions of the construction project to fruition. Their 50% - 50% ownership position suggests appropriate checks and balances will be in play to govern their negotiation of the contracts for management of construction and day-to-day operations at LGS. Disclosure of those contracts, and any amendments, to the Commission will provide another check. We will require such disclosure to the Director of the Commission's Energy Division as a condition of our approval of the transfer of control.
3 By ruling on January 4, 2002, the ALJ granted Joint Applicants' motion for leave to file under seal certain terms and conditions in the Unit Purchase Agreement, as well as certain other commercially sensitive, confidential information. 4 Footnote 3 to the Application states that Western Hub also owns, indirectly (1) an 18.5% interest in CenTex Market Center, L.P. and (2) a 25% interest in undeveloped gas storage sites in Texas and in California. None of these holdings is the subject of the authority sought in this proceeding. 5 At the time the Application was filed, UtiliCorp owned 80% of Aquila Inc., having successfully placed the other 20% in public hands through an initial public offering in April 2001. According to the Application, UtiliCorp intended to spin off its 80% interest in Aquila Inc. to its shareholders by April 2002. However, those plans changed. The November 2002 Amendment to the Application states that UtiliCorp's board of directors determined to acquire all outstanding public shares of Aquila Inc. via a tax-free exchange of 0.6896 shares of UtiliCorp common stock for each share of the Class A common stock of Aquila Inc. and then to merge Aquila Inc. with an UtiliCorp subsidiary in a stock for stock transaction. The Amendment to the Application recognizes that this change of plan renders moot Joint Applicants' request, in the Application, that the Commission authorize the "spin-off" of the remainder of Aquila Inc. in its decision on the Application. 6 Once its expansion project is finished, the Katy Facility will have the capacity to cycle working gas 5+ times (or "turns") per year. 7 Wild Goose was the first competitive, natural gas storage utility to receive a CPCN from the Commission. LGS was a party to the recent expansion proceeding. 8 AMS would assume contractual responsibility for all contractors to complete the Lodi Facility on time, within budget and in compliance with specifications. Thus AMS, as the turnkey contractor, would "wrap" the obligations of all of the subcontractors - if a problem were to occur, the project owner could claim against the turnkey contractor who in turn could claim against responsible subcontractors. 9 The ban is specific to Wild Goose; dicta in Wild Goose Expansion state "this prohibition ... is not intended as precedential toward any other independent storage operations." (Id. at footnote 1.) 10 The Affiliate Transaction Rules, adopted by D.97-12-088 as subsequently modified by D.99-09-002, govern relationships between energy utilities and their affiliates and resulted from proceedings the Commission initiated in 1997 in light of fundamental changes in the California electric and gas markets stemming from electric restructuring and the consequent potential for utility/affiliate self-dealing and cross-subsidization. D.00-05-048 granted LGS an exemption from the Affiliate Transaction Rules because like Wild Goose, LGS had not been made a respondent to the rulemaking that promulgated those rules and because the Commission had determined that, at that time, like Wild Goose:- ... it [LGS] does not possess market power in the California gas storage market or the ability to cross-subsidize LGS' affiliates with ratepayer assets at this time... (D.00-05-048, 2000 Cal. PUC LEXIS at *99.)
