August 2006

Allegheny Energy — A Model of Recovery

By Joe Kalasky

Allegheny Energy's recovery following the turbulent days of the energy trading market is an outstanding example of an internally driven revitalization. While the volatility in energy trading has moderated, and most utilities have shown only moderate performance since the onset of deregulation, Allegheny Energy has set itself apart, outpacing all electric utilities since 2003.

This remarkable performance can be attributed to the complete strategy change set forth by Allegheny Energy's new CEO, Paul J. Evanson. In just three years under his tenure, the company's market value has increased from about $1 billion to nearly $6 billion. In 2005, the stock price rose by 61 percent, placing Allegheny Energy at the top of its peer group as rated by the Citigroup Index. The median growth in the same group was only 3 percent. In recognition of this accomplishment, GAMCO Investors, Inc., inducted Evanson into its Management Hall of Fame.

So, how did Evanson bring Allegheny Energy back from the brink?

Allegheny Energy, headquartered in Greensburg, Pa., is an investor-owned electric utility consisting of two major businesses: Allegheny Energy Supply and Allegheny Power. Allegheny Energy Supply owns and operates 24 generating stations with a total generating capacity of more than 10,100 MW. Allegheny Power serves approximately 1.5 million customers with a network that includes 68,000 miles of distribution lines, 5,000 miles of transmission lines and more than 1,200 substations. The service area includes parts of four states: Pennsylvania, Maryland, Virginia and West Virginia. The combined businesses are operated by a team of more than 4,300 employees.

The Allegheny Energy of 2006 stands in stark contrast to the company in late 2002, when it was on the brink of bankruptcy. The former management team wanted to transform Allegheny Energy into a national energy supplier. Allegheny Energy expanded generation into 15 states by purchasing existing generation and had plans to build new generation as far off as Arizona. Allegheny Energy also purchased the energy trading division of Merrill Lynch and Co. With this acquisition, Allegheny Energy's energy trading shifted from asset-backed, short-term trading to more speculative activities. This expansion was financed primarily through debt. Beginning in 2002, difficult market conditions, changes in the regulatory environment and the company's worsening profile placed Allegheny Energy in a precarious financial condition with more than $5 billion of debt.

With the company on the verge of bankruptcy, the Board of Directors moved to bring in a new management team. Naturally, that process began with the selection of a new CEO. Paul J. Evanson, president of Florida Power and Light Company, was the ideal candidate. Evanson, well respected on Wall Street, brought strong utility experience, operational and financial skills and a strategic vision to Allegheny Energy.

Evanson immediately assembled a new upper management team that shared his vision and had the multifaceted skill sets to refocus and improve Allegheny Energy.

Allegheny Energy returned to its historic business model with a long-term commitment to its core generation and transmission and distribution businesses. The greatest challenge was to quickly refinance the huge debt and become current in its financial reporting.

The next step in the financial recovery was the sale of non-core generation assets which had been purchased in the growth initiative. In addition, energy management and gas companies were sold to provide much-needed capital, reduce debt and regain focus on the core electric utility business. Also, the energy trading group was reorganized to focus only on the company's physical generating assets.

Once losses were halted, the vision was to dramatically improve the operating performance of the corporation. In 2004, Allegheny Energy launched its High Performance Organization (HPO) program. The initiative cuts across all levels and organization structure, touching every employee in some way. The HPO goal is for Allegheny Energy is to be in the top quartile of performance compared with industry peers. Rigid benchmarks have been established for each business unit and balanced scorecards measure performance. The Six-Sigma process is one of the principal tools used to improve operating efficiency. Various Six-Sigma teams have been established to focus on solutions to strengthen performance and efficiency.

As proof of its regained financial strength, in May 2006 Allegheny Energy announced an ambitious plan to build more than 210 miles of 500-kV transmission line, extending from western Pennsylvania to West Virginia, western Maryland and Virginia. The new lines will improve system reliability and increase west-to-east transfer capability, making cost-effective generation available to more consumers.

All of the recent successes were fostered in a regulatory environment built upon mutual trust and respect. Allegheny Energy has a long-standing tradition with federal and state regulatory agencies as a utility that can be trusted to work for the benefit of customers and the environment. Allegheny Energy still has some of the lowest electric rates in the region and meets or exceeds environmental policies and regulations. In May 2006, Allegheny Energy was ranked number one in customer satisfaction by the American Customer Satisfaction Index.

Today, Allegheny Energy is widely recognized for executing a remarkable financial turnaround and is now poised to execute its growth strategy.

Joseph A. Kalasky, P.E., a distribution engineer for Allegheny Energy, is a member of IEEE-USA's Government Activities and Employment and Career Services Committees, as well as the IEEE Ethics and Member Conduct Committee. He served on the IEEE Board of Directors in 1999-2000. Comments may be submitted to todaysengineer@ieee.org.