Chadbourne held a conference call on November 12 to talk about what a Bush second term will mean for the project finance community, what energy and tax changes to expect in the coming term and what to do differently in deals in anticipation of these changes. Three panelists from Washington spoke for five minutes each at the start of the call, and then the audience asked questions. The panelists are Eugene Peters, chief lobbyist for the Electric Power Supply Association, the trade association for the US independent power industry, Keith Martin with Chadbourne in Washington, and Jonathan Weisgall, vice president for regulatory and legislative affairs for MidAmerican Energy Holdings Company, a holding company for electric and gas utilities that serve parts of Iowa, Nebraska, Illinois and South Dakota and for gas pipelines that serve the western United States and Texas. MidAmerican is also active in developing wind farms and geothermal projects. Two other Chadbourne lawyers – Adam Wenner and Roy Belden – helped answer questions.

MR. MARTIN: Jon Weisgall, what are you telling management to expect in the next year or two now that the Bush administration has been returned to office and now that the Republicans have larger majorities in both houses of Congress?

Energy Bill?

MR. WEISGALL: One caveat: these are my views. I am not speaking for MidAmerican.

Let me start with politics and timetables and then turn to substance. On votes: first of all, the House of Representatives is largely unchanged, and there is room for debate about what the new 55-vote margin the Republicans will hold in the Senate means. Senator George Allen (R-Virginia) was quoted as saying, “We have more than enough votes for an energy bill.” I don’t see the count that way. I see an increase of perhaps one net vote for something that looks like the energy bill that the Bush administration tried unsuccessfully to put through the current Congress.

On process and timetable, let’s talk about the House, Senate and White House in that order. Joe Barton (R-Texas), the chairman of the House Energy and Commerce Committee, is saying he will not do a comprehensive energy bill next year. He is tired of waiting for the Senate to reach a consensus on what it can accept. His committee has other issues on its agenda, like the reauthorization of the Clean Air Act. The key question is where is the House leadership? Are we going to see continued record prices for coal, gasoline, natural gas and oil and, if so, will they force action? These are open questions.

On the Senate side, Joe Barton’s counterpart, Pete Domenici (R-New Mexico), chairman of the Senate Energy and Natural Resources Committee, was quoted by a spokesperson as saying, “We are going to start from scratch next year.” I don’t think this is a formula that will lead to an energy bill early in 2005, and with tax reform, social security reform and health care issues also pressing for attention, energy may find itself lost in the shuffle.

Turning to the White House, energy should be a high priority, but the Bush administration did not take a hands-on approach to energy during its first four years in office. We all heard President Bush say in his press conference two days after the most recent election, “I think I earned capital in the campaign, political capital, and now I intend to spend it.” That may indicate a more assertive White House in the next couple years.

Moving to substance: I think the Republican leaders in the House will stick pretty much to the energy bill that failed to pass the current Congress. At the same time, we will see a more aggressive push on the supply side by the Senate. There may be some small changes around the edges of the electricity title in the bill, but the three core components remain reliability of the transmission grid, repeal of the Public Utility Holding Company Act and backstop siting authority of transmission lines for the Federal Energy Regulatory Commission. We will see another push on opening up the Alaska National Wildlife Refuge to oil drilling. I don’t think ANWR drilling will make it into any energy bill that is enacted. Congressional leaders could try to use something called the budget reconciliation process in the late spring to move ANWR. The attraction to them of the budget process is a proposal needs only 51 votes to clear the Senate instead of the normal 60 votes that it takes to break a Senate filibuster.

I will defer to Keith on tax issues, but everyone note that Judd Gregg (R-New Hampshire) is taking over as chairman of Senate Budget Committee. Gregg will bring pressure to cut the deficit in half without raising taxes over the next four years. The new watch words will be fiscal restraint.

Moving to the challenges facing the next Congress: one is settling the MTBE issue that caused the energy bill to stall in the current Congress. The issue is whether to limit the liability of producers of a gasoline additive from MTBE from lawsuits. Another challenge will be to hold the electricity title together. There are several stakeholders who would like to make changes in the electricity language in the energy bill. They would like to make what they think are improvements. The electricity language struck a delicate balance among competing interests. A third challenge will be domestic natural gas production. There is a welcome bipartisan initiative being led by Senators Tom Carper (D-Delaware) and Lamar Alexander (R-Tennessee) to look not only at how to increase the domestic supply of natural gas, but also at two other pillars: energy efficiency and fuel diversity. We may see some interesting proposals.

Another challenge is how to increase the fuel supply in an era of huge budget deficits and fewer dollars available for tax subsidies? Tax incentives are an easy way to take care of the issue. It will be harder to increase supply when the only tool the government has left in its tool box is opening up certain federal lands for exploration and drilling.

Another challenge is on the nuclear side. Pete Domenici is already out of the starting gate pushing for more incentives for the nuclear industry. He will run into a roadblock named Harry Reid, the incoming Senate minority leader from Nevada and a strong opponent of anything nuclear. Nevada is the national repository for nuclear waste. Another challenge is how to encourage imports of liquefied natural gas. Lee Terry of Nebraska is one Congressman who is already working on a bill to streamline permitting regulations.

Turning to environmental issues, the Bush administration has a “clear skies” initiative. It was proposed some time ago and has never made it out of a subcommittee in Congress, let alone a full committee or the full House or Senate. Maybe we will see movement. It will depend on the ratio of Republicans to Democrats on the key committees next year.

Climate change: even though this administration will be under mounting national pressure to take action, I do not see any progress anytime soon. The key question for the Senate Democrats is: Do you want to make a deal? You have some pretty challenging elections coming in 2006. You have a lot of freshmen Senators running for reelection as well as some older Senators like Daniel Akaka (D-Hawaii), Robert Byrd (D-West Virginia), Ted Kennedy (D-Massachusetts) and Paul Sarbanes (D-Maryland). The freshmen who will be up for reelection include Bill Nelson (D-Florida), Ben Nelson (D-Nebraska), Maria Cantwell (D-Washington), Tom Carper (D-Delaware), Mark Dayton (D-Minnesota) and Jon Corzine (D-New Jersey), who is already saying he may run for governor. The question for the Senate Democrats is whether they want to do a deal now or push this farther into the future.

The question for the Republicans is: How much do you want to get your agenda done? You succeeded in defeating Tom Daschle (D-South Dakota), which has implications for the energy bill since Daschle was a supporter. Is now the time to go for energy, and how are you going to get the House, Senate and White House to go along? I don’t think an energy bill is inevitable next year, notwithstanding the conventional wisdom that it should now be a slam dunk after the latest elections. I think there has been only a modest increase in support.

The Republicans in the two houses are still not on the same page on procedure for how to get the energy bill done. The environmental issues are going to be brutal again. ANWR has a decent chance of getting done, if it can be done as part of a budget reconciliation process, separate from an energy bill.

Finally, I did not mention the Alaska natural gas pipeline project because the current Congress pretty much legislated all the incentives necessary to move that project forward, with the possible exception of price supports.

MR. MARTIN: Gene Peters, Jon Weisgall says he thinks the election will bring just one more vote for an energy bill. Are you as pessimistic about its prospects, and what else should one expect in the next year or two?

MR. PETERS: Jon did a superb job of summarizing a wide range of issues that should be of interest to the people on the call. I will try to avoid being redundant, but it may be hard.

Last year, the Republican vote counters in the Senate figured they needed just three more votes to get an energy bill, and that is because Senator Ensign (R-Nevada), who initially voted for the bill, then said he was going to vote against it. A key Republican staffer said recently that he thinks the Republicans picked up three votes for the energy bill in the November election. I do not think that is right. My own view is the bill picked up one or two votes, but not three. The next question is do the Republicans really need only three votes to pass the bill, or does a three-vote gap really mean that four votes are needed. The jury is still out.

Let me review a number of topics on which Jon Weisgall touched briefly. Jon mentioned the MTBE controversy and incentives for nuclear power. It is hard for me to imagine that Joe Barton, the House Energy Committee chairman, will let big pieces of the energy bill move forward without a resolution of the MTBE issue. At the same time, it is hard for me to imagine that Pete Domenici, Barton’s counterpart in the Senate, will let big pieces of the energy bill move without a few things that he wants. One of them is new production incentives. Barton said that he will not try to do an energy bill again next year; he was worn out by the last effort to pass the bill. I would not read a lot into that. The House can pass an energy bill any time it wants. I think all Barton is saying is the bill will not be a priority for him until the Senate acts. You cannot fault him for that position, given how the bill always grinds to a halt in the Senate. If the Senate acts, then the House will pass the bill and Barton could end up chairman of the conference committee that would be appointed to iron out differences between the House and Senate versions of the bill.

The only way an energy bill can pass the Senate is if it reflects the geography of the Republican caucus. Right off the bat, the Senate Energy Committee staff have said the committee will not simply repackage the bill that failed to pass the current Congress and put it to another vote. The committee plans to start over. The chairman, Peter Domenici, has been talking about trying a more bipartisan approach the next time. The way the last energy bill was constructed was by looking primarily to Republican caucus and what had to be in the bill to line up the required number of votes.

With hindsight, that was a losing strategy. The temptation will be to try to do the same thing again now that there are more Republicans in the Senate. That may prove a losing strategy again.

One thing to keep in mind is that both the chairman and the ranking Democrat on the Senate Energy Committee are from the same state, New Mexico. The chairman is Pete Domenici. The ranking Democrat is Jeff Bingaman. If Domenici is serious about undertaking a more bipartisan effort next time, one would think it should be easier for two New Mexicans to do. Early signs are good. The Republican and Democratic committee staffs are starting to talk to each other for the first time in months.

Two other items: we pay a lot of attention at the Electric Power Supply Association to the relationship between Congress and the Federal Energy Regulatory Commission. You have a FERC commissioner – Suedeen Kelly – whose nomination to serve a second term is being held up by the Senate. The hold has nothing to do with her and everything to do with a dispute involving the Nuclear Regulatory Commission. Negotiations are underway to free her nomination. [Ed.—The Senate confirmed Ms. Kelly to a second term in late November.] The term of the FERC chairman, Pat Woods, ends in June. The conventional wisdom is that he cannot be confirmed again. I think that may be wishful thinking. It would not be easy for him to be confirmed for another term, but he still seems to have the backing of the Bush administration. The point is you have holes developing on the commission. FERC is already short one commissioner, even before the troubles for Suedeen Kelly and Pat Woods.

The other thing I want to talk about is the interaction between FERC and Congress. There were tensions during the first Bush term.

The commission has been in favor of regional transmission organizations, or RTOs. This has put it at odds with a Republican caucus in Congress that leans heavily toward the South and West in terms of its geographic interests. The commission will find it more difficult to do the things that still need to be done on market power mitigation, RTO development and similar core issues in the face of a lot of potential pushback from the Senate Republican caucus. There are several Texans in key leadership positions in the House, which probably helps Pat Wood in his dealings with the House, but the Senate is not a friendly place for him and he will have to pay close attention to what the Senate wants in setting his agenda, particularly if he wants to serve another term.

Tax Simplification

MR. MARTIN: Gene, thank you. Let me speak briefly about what to expect on the tax front, and then we will open the floor to questions.

President Bush has made simplifying the US tax code a central theme of his second term. There is considerable skepticism in Washington about whether tax reform will occur at all and, if it does occur, whether it can be done quickly. The President also talked about tax simplification during his last campaign in 2000, and the Treasury Department produced an options paper two years ago, but there was no followup.

Pamela Olsen, who was the assistant Treasury secretary for tax policy in the Bush first term, warned in a cover memo to the US Treasury secretary in 2002 when she delivered the options paper that any overhaul of the US tax code is likely to have “vocal losers and largely silent winners.” She also noted that adoption of a consumption tax, which is a favorite of Republican conservatives, has led in other countries to election losses for the incumbent party.

One can speculate endlessly about the prospects for major tax simplification. Here is all that can be said today as fact.

First, the President plans to name a bipartisan panel before the year ends to look at options for a major overhaul, with instructions to report back as soon as possible in 2005.

Second fact: the overhaul is supposed to be revenue neutral.

Third, the deductions for mortgage interest and charitable contributions are off limits and, fourth, the administration wants to tax consumption and reward investment, or as Bush said during his news conference on November 4, he wants to reward risk taking.

The bipartisan panel will probably use the Treasury options paper from two years ago as a starting point for its discussions. There were five options in that paper, but they distill essentially to just three broad approaches for business. One recommendation was to tax businesses on their gross receipts after certain deductions. For example, a business would tally up its gross receipts, deduct the cost of the goods it purchased from other companies, deduct the wages it paid, and that would be its tax base. It would not be allowed to deduct interest. Alternatively, the Treasury suggested keeping the existing income tax, but taxing corporations on the book income that they report to shareholders, stripping the system of most tax credits and deductions and reducing the tax rate. Dividends, interest, rents and royalties would not be taxed to recipients. The third broad approach in the Treasury options paper is to impose a value added tax – either in conjunction with the existing income tax or as a replacement. Value added taxes are common in Europe and other countries. They operate something like a national sales tax.

Tax simplification will be complicated by two realities. One is that House Republicans will be pushing early in the next year to make permanent three so-called middle class tax cuts that President Bush bragged about during the campaign. They are scheduled to expire in 2010. Making them permanent would add another $2.2 trillion to the national debt through 2014. That would increase the US debt by one third. The second reality is there are 22 tax breaks that expire at the end of next year, and the corporate tax bill that the President signed just three weeks ago added another 26 tax breaks that will expire between 2006 and 2010. There will be pressure to extend them.

What should one conclude from all of this?

My own guess is that major tax changes, if they are to be made, are a 2006 item. The second conclusion is whether there will be a significant overhaul in the US tax code depends on whether a consensus develops about what to do. It is too early to tell whether a consensus is even possible. Third, the Bush administration will have a hard time selling any tax overhaul that reduces taxes further on investment income while taxing consumption more heavily. The distributional effects of this are not very appealing.

Wind developers, geothermal developers and owners of other renewable energy projects will be pushing next year for an extension of production tax credits for their projects. There is not the money, given other priorities, to make these tax subsidies permanent. I do not see an extension until late summer at the earliest, unless it is part of an energy bill that moves earlier in the year.

Any significant overhaul of the US tax system would change how companies raise capital and how projects are financed. For example, if interest is no longer deductible, which would be the case under most of the Treasury options, but interest and dividends are not taxed to the recipient, would there be any need for the tax-exempt bond market? Probably not. Schools, roads, hospitals and other public facilities would lose the advantage they possess today in competing for capital. The balance between debt and equity would shift. Borrowing may be less attractive. Corporate capital structures and financing strategies would have to be re-thought.

Finally, the corporate tax overhaul, if it occurs, could also reduce or eliminate the benefit companies receive from existing tax subsidies – for example, for investing in renewable energy projects. Institutional equity investors putting money into such deals would be wise to take the risk of major tax simplification into account in their pricing and, in some deals, they may want to leave themselves an out. There are always transition rules when Congress changes the tax laws dramatically, but it is hard to preserve the full value of these tax breaks in a transition to lower tax rates.

Let’s open the floor to questions. The way to ask a question, because we have so many people on the call, is to send the question by email. Questions have already been coming in while the panelists were talking. Let me ask Jon Weisgall, you are not very optimistic about the prospects for an energy bill next year. Isn’t the real problem lack of a consensus in Congress about what to do?

Energy Crisis?

MR. WEISGALL: Congress acts only in two situations: crisis or consensus. You would have thought the blackout in August 2003 in the northeastern US and Canada would have galvanized Congress to respond to crisis. It did not happen.

Congress has been looking at energy legislation for six years. Several of those years were when the Senate Energy Committee had a Democratic chairman, Jeff Bingaman (D-New Mexico). Then we had Frank Murkowski (R-Alaska), who left to become governor of Alaska, and then Pete Domenici (R-New Mexico) took over. The Democratic and Republican energy bills proposed during the last six years have a lot of overlap, probably 85 to 90% overlap, so there is a great deal of consensus.

I think the single biggest problem last year, when there was a close vote, was poor political timing. The Medicare bill had just passed, and the idea of handing President Bush two legislative victories in such a short period did not appeal to Democrats. The vote on the energy bill in the Senate was very close. You had a lot of Democrats from the Midwest who wanted a bill because of the ethanol provisions. You had about a 90% consensus, but politics got in the way.

The issue next year will be whether the different interest groups are willing to show enough flexibility to overcome the remaining 10% gap.

MR. MARTIN: Gene Peters, is another problem that there is no agreement on whether there is even an energy crisis that needs to be addressed?

MR. PETERS: I don’t think that is the problem. The real question is: Why is this so hard? Jon is exactly right. If you look at what the Bingaman energy bill looked like when it was crafted by Democrats, and compare it to the Domenici bill, it is at least 80% the same stuff. I think the real problem has been the partisan rancor in Congress. The situation was not helped by the way the last energy bill was put together. I actually think the next Congress will pass an energy bill. I just don’t think it will happen quickly.

MR. MARTIN: In 2005? In early 2006?

MR. PETERS: The problem with Congress is that it works on a two-year cycle, and once you get past late spring of the first year, everything slows down. An energy bill will either get done very early in 2005 or not until 2006.

PURPA and PUHCA

MR. MARTIN: Jon Weisgall, if there is an energy bill, will it repeal PURPA – the 1978 law that requires electric utilities to buy electricity from independent power producers?

MR. WEISGALL: That’s very interesting. As I mentioned earlier, there are three fixed components in the electricity title of the bill. They are backstop siting authority for transmission lines for the Federal Energy Regulatory Commission, PUHCA repeal and reliability. Repeal of the PURPA purchase requirement is also part of the electricity title. The electricity title was a bit of a third rail in the early years of energy bill consideration. It has become less controversial over time. It is no small feat that all the major stakeholder groups – rural electric cooperatives, municipal utilities, investor-owned utilities – came together and crafted an electricity title that includes PURPA repeal. PURPA repeal is a big issue for the investor-owned utilities and, in the interest of full disclosure, it is a big issue for my own company.

So to answer the question, if an energy bill is enacted, or even if pieces of the bill are enacted as separate measures – for example, an electricity measure, a separate nuclear energy bill, a separate natural gas bill – then I think PURPA will be repealed.

MR. MARTIN: Gene Peters, is the independent power industry fighting against PURPA repeal?

MR. PETERS: No and, in fact, a number of our members would like to see it repealed. I agree with Jon: if an energy bill is enacted, then PURPA repeal will be part of it.

The only thing I would say is that if I were Pete Domenici and I were serious about making the process more bipartisan, then the easiest way to do it would be to give in to the enhanced FERC merger review authority that Jeff Bingaman wants in exchange for PURPA repeal. FERC has had to wrestle recently with a number of proposed sales of generating plants to investor-owned utilities. At least one transaction was structured in a way that the participants thought would avoid any kind of FERC review. Some FERC commissioners were unhappy about the situation and would like the commission to have broader authority to review such transactions. The issue is now part of the electricity equation. Bingaman has made broader authority for FERC his price for going along with PURPA repeal. It is something that Domenici will be considering.

MR. MARTIN: Let me bring Adam Wenner into the conversation. Adam, many people have thought that a 1935 law called the Public Utility Holding Company Act – or PUHCA – was a barrier to stitching together a multi-state power company. Do you have a view on whether this law will be repealed, and does it really matter whether it is repealed? Haven’t people found ways to work around it?

MR. WENNER: I defer to Gene and Jon on the prospects for repeal, but repeal would have a significant effect on US utilities. The reason that acquisitive US utilities want PUHCA repealed is so that they can acquire more than passive interests in other utilities, or more than 5% of the voting securities of other US utilities, and realize the economies of scale that other businesses achieve by expanding. Repeal would let non-utility companies, like Bechtel or Microsoft, acquire utility subsidiaries. It would also make it easier for non-US companies to do so.

MR. MARTIN: I was going to ask what change you would expect in the domestic power market if PUHCA is repealed, but it sounds like you would expect to see more utility acquisitions, at least in the short term?

MR. WENNER: More, but you cannot say more concentration. While PUHCA prevents utilities from owning scattered utility subsidiaries, a separate FERC market power test prevents utilities from acquiring other utilities in the same market, or at least other utilities that own power plants. If PUHCA is repealed, then a MidAmerican would be free to acquire a utility subsidiary in Maine or California, but it would still have to pass the market power test administered by FERC, and toughened by the proposed legislation, before it could acquire other utilities with generating plants in the same market or in the same market region where it is already operating.

MR. MARTIN: What would PUHCA repeal mean for independent generators?

MR. WEISGALL: PUHCA repeal would bring a huge amount of new investment into the marketplace. I am guessing that would be a help. We do not have a completely competitive electricity market today because of the barrier to entry that PUHCA creates.

MR. MARTIN: Okay, another question: we talked earlier about the view of this panel that any energy bill that is enacted will probably repeal the part of the Public Utility Regulatory Policies Act that requires utilities to buy electricity from independent generators. How would existing independent power projects be affected? I am thinking of a project with an existing contract to sell its electricity to a utility.

MR. WENNER: The repeal provision, as currently written, would only apply in regions where the Federal Energy Regulatory Commission finds there is a competitive wholesale power market. Therefore, for a project in a part of the country where there is not such a market, the mandatory purchase obligation would remain. Even in places where there is a competitive market, existing contracts would not be affected. Such contracts would be grandfathered, but what would happen is that at the end of the term, the independent generator could not demand a new such arrangement.

Environmental Outlook

MR. MARTIN: Let me shift gears and ask Roy Belden in New York a question. President Bush has a “clear skies” initiative. It is a legislative proposal that would require further reductions in air emissions from power plants. I believe it covers mercury, nitrogen oxide and sulfur dioxide. Can such a bill pass a Republican-dominated Congress?

MR. BELDEN: The bill will face an uphill battle in the next Congress, notwithstanding the larger Republican majorities. The Senate Democrats blocked the proposal in the last Congress, and it never made any progress in the House.

MR. MARTIN: The Senate Democrats wanted tougher restrictions?

MR. BELDEN: That’s right. The ranking member on the Senate Environment and Public Works Committee is Senator James Jeffords (I-Vermont), and he leads a faction that wants much steeper cuts in mercury, nitrogen oxide, and sulfur dioxide as well as carbon dioxide. The Democrats would like to see a four-pollutant bill. The Bush administration is strongly opposed to bringing in carbon dioxide reductions; it wants a three-pollutant bill. The Senate Environment and Public Works Committee will probably have a 10-to-eight split in the next Congress in favor of the Republicans, but you have one Republican Senator, Senator Lincoln Chafee from Rhode Island, who often sides with the Democrats on environmental matters. That would make the vote even. The Bush plan faces a better chance in the full Senate if it can make it out of committee.

MR. MARTIN: You made the point to me earlier that it doesn’t matter whether the Bush clear skies bill clears Congress. The Environmental Protection Agency is moving ahead with a plan of its own to restrict air emissions. What does the EPA action mean for power companies, and by when must they take action?

MR. BELDEN: The Bush administration is pursuing a parallel track. The Environmental Protection Agency has proposed a clean air interstate rule that would require reductions in sulfur dioxide and nitrogen oxide emissions. The rule is expected to go final later this year. The targets in it are similar to the targets in the clear skies bill that the President sent Congress. However, one significant difference is that the clean air interstate rule applies to 29 states – basically in the East, Midwest and South – while the clear skies act, if it is ever enacted, would apply nationwide.

MR. MARTIN: So power plants in 29 states will have to take action under the new EPA rule?

MR. BELDEN: Right. The clean air interstate rule adopts a two-phased approach. There will be emission reduction targets for sulfur dioxide and nitrogen oxide that must be met by the end of the first phase in 2010. The second phase targets must be met by 2015. Ultimately, you end up with reductions on the order of about 70% from current sulfur dioxide emission levels and about 65% for nitrogen oxide emissions.

MR. MARTIN: Will owners of even the newest power plants have to take action to reduce emissions from them, or are the targets a concern only for older utility plants?

MR. BELDEN: The greatest impact will be on older plants, and particularly older plants that do not have some of the current state-of-the-art technology for pollution control. Newer plants with state-of-the-art controls are less likely to be affected.

The other measure that I wanted to mention is the clean air mercury rule that the Environmental Protection Agency proposed. EPA proposed two alternatives for reducing mercury emissions. The favored approach is a cap-and-trade approach, where there would be a 34-ton mercury emission cap that would start in 2010, and then a 15-ton cap that would take effect in 2018. So ultimately, you end up with mercury reductions on the order of about 70%.

Various Fuels

MR. MARTIN: I have been trying until this point to group the questions from the audience by topic. Now let me switch to asking questions in no particular orde