Since FirstEnergy Corp. announced its $4.7 billion acquisition of Greensburg-based Allegheny Energy Inc. in February 2010, the Akron, Ohio-based buyer has said it will close seven of the 10 coal-fired power plants that it picked up in the purchase.
FirstEnergy also is looking to sell two-thirds of its hydropower assets, much of which came from Allegheny Energy.
So what was the company thinking?
"I'm sure there's some equity analysts asking the same question," said Gimme Credit analyst Philip Adams.
Today, FirstEnergy is looking at its regulated companies to pull in the steady cash where the unregulated market is flailing. Pennsylvania, a deregulated state where the cost of generation is not recovered from ratepayers, may not be all that attractive at the moment.
But the other assets acquired from Allegheny Energy -- its transmission company, utilities and its power plants in regulated states -- are.
"[FirstEnergy] is synthetically re-creating a regulated utility," Mr. Adams said, meaning it's trying to match what it produces with how much energy its customers demand.
For example, the Ohio company is trying to swap ownership of two of Allegheny Energy's former coal plants between its subsidiaries. It has petitioned regulators to allow Mon Power, a regulated utility in West Virginia, to buy for $1.2 billion the remaining 80 percent of the Harrison Power plant in Haywood, W.Va., from an unregulated FirstEnergy subsidiary.
FirstEnergy said the transaction would help Mon Power, which is short on power and must buy from another producer, to satisfy its load obligations. But West Virginia regulators have charged that the deal is meant to shift the burden of operating and retrofitting the plant from the company to ratepayers in West Virginia.
In an investor presentation in June, FirstEnergy stated that Mon Power is "expected to recover all fuel, purchased power and variable [operation and maintenance] costs" along with the remaining costs of purchasing the plant. First, it would do it through temporary surcharges on its customers and, eventually, the costs would be factored into their base rates.
"You're getting ratepayers to pay for it, but that's not patently unfair," Mr. Adams said. In many states, customers bear the cost of generation. That's why nuclear plants are being built in states with cost recovery regulations and not in deregulated markets, he said.
Pennsylvania is a deregulated market, which means utilities don't own generation. They buy it, often from affiliated companies, as was the case with Allegheny Energy and as now happens with FirstEnergy, which sells the output of its plants to its 11 utilities.
The rationale behind severing generation and distribution was the hope that generators, who couldn't charge customers a rate that guarantees a return, would have an incentive to upgrade their plants and run them as efficiently and profitably as possible.
Even more attractive than generation subsidized by ratepayers is transmission -- the term for building and operating the powerlines that carry electricity from power plants to utilities.
After its merger with Allegheny Energy, FirstEnergy acquired the Trans-Allegheny Interstate Line, or TrAIL, which went into service just three months after the merger closed.
"The beautiful thing about transmission, and why people are far more interested in investing in transmission than generation, is that it's different regulation -- and higher authorized rate of return," Mr. Adams said.
The rate of return on equity allowed for TrAIL is 12.7 percent, a very good deal, according to Scott Solomon, vice president at Moody's Investors Service Inc.
When, in February, Moody's changed the outlook on FirstEnergy's debt to negative, citing market conditions, the company's transmission assets remained the highest rated among the family of peer companies.
"We, as a rating agency, love FERC-regulated assets because the return is strong and predictable," Mr. Solomon said. The Federal Energy Regulatory Commission decided in 2005 to allow attractive returns to incentivize building pipelines that would relieve congestion and increase reliability.
That might put into perspective FirstEnergy's decision to close coal-powered plants and then spend $700 million on transmission projects to mitigate the lost capacity from those plants. In a recent investor presentation, the company emphasized that the $700 million investment comes with "stable, predictable and attractive financial returns."
The Allegheny Energy deal held even more promise for transmission opportunities when it was inked. At that time, another transmission project, the $1.3 billion PATH -- or Potomac-Appalachian Transmission Highline -- that was supposed to run some 270 miles across several states including Pennsylvania, was still on the table. The FERC-approved rate of return for that project was 14.5 percent.
But the regional grid operator canceled the project in mid-2012, citing low power demand.
From the time FirstEnergy announced it would acquire Allegheny Energy -- a company whose generation mix was far more coal-heavy than its own -- it sought to reassure investors and customers that environmental regulations wouldn't be a problem.
"Well-positioned to meet EPA standards," declared an investor presentation from June 2011, and FirstEnergy's CEO frequently touted the environmental quality of Allegheny Energy's fleet.
Mr. Solomon, at Moody's, said there was no talk of closing plants during the merger process, and FirstEnergy spokeswoman Jennifer Young confirmed it wasn't on the radar, even though EPA rules were anticipated to be costly.
"At the time of the merger, we really anticipated that the markets would recover much differently," Ms. Young said.
Early last year, FirstEnergy came up with an initial estimate for what it would cost to outfit its plants with equipment to trap mercury and air toxics as proposed by EPA's rules.
Originally, the company thought it would cost $1.3 billion to comply. Then it revised the figure to $975 million, then to $925 million. Ms. Young said the estimate came down as the company took a closer look at which equipment it would have to buy and which it could alter to comply.
In addition, FirstEnergy secured waivers for several coal plants, including Hatfield's Ferry, to delay the compliance deadline until April 2016.
When FirstEnergy announced this month it would close Hatfield's and Mitchell by October, the environmental cost estimate dropped to $650 million, much of which will be recovered from ratepayers.
The announcement was a surprise, but not a shock to Cecil-based coal supplier Consol Energy Inc., which had already ranked Hatfield's Ferry as a "possible shutdown candidate" and decided not to market its coal to the power plant, according to spokeswoman Lynn Seay.
While it has become customary to follow the announcement of a coal plant closing with rallies against the EPA -- and that is certainly happening this time around with calls from unions and lawmakers to ease up on the industry -- Ms. Young said some closures probably would have been necessary even without the tighter environmental regulations. "Because the economy is the bigger driver here, we'd still have to make those difficult decisions," she said.
The economy is also behind the company's decision to market its hydropower assets, including a pumped storage station in Warm Springs, Va., that FirstEnergy co-owns with Dominion Resources. Dominion, through its spokesman Jim Norville, declined to say whether it would buy FirstEnergy's stake in the facility.
Anya Litvak: firstname.lastname@example.org or 412-263-1455