Allegheny Energy, Inc. Business Information, Profile, and History

Company Perspectives:

Allegheny Energy, Inc. (NYSE: AYE), headquartered in Hagerstown, Md., is a strong, diversified energy company on the leading edge of change. We are excited by the challenge of deregulation and dedicated to the goals of increasing shareholder value, becoming a national supplier of energy and value-added energy-related services, and diversifying into other ventures related to our core business which enhance value.

History of Allegheny Energy, Inc.

Allegheny Energy, Inc. controls both regulated and unregulated generation facilities and owns 8,593 megawatts of power. It provides electricity to markets in several mid-Atlantic states, primarily Pennsylvania and West Virginia, as well as parts of Maryland, Ohio, and Virginia. The decline of the steel industry since the 1950s has changed the revenue mix at Allegheny significantly. To supplement its shrinking base of industrial customers, Allegheny increased sales to the residential and commercial sectors, while also taking advantage of its low-cost, coal-fired generators to sell large amounts of electricity to other utilities. This latter source of revenue, however, was threatened by the 1990 Clean Air Act Amendments, which forced Allegheny to spend in the neighborhood of $2 billion for new pollution control devices, mainly scrubbers for its high-sulfur coal plants. In answer to this new challenge, Allegheny diversified its holdings to include natural gas facilities in West Virginia and several Midwestern states. The company reorganized in 1997 in response to deregulation, with the goal of taking advantage of the newly opened energy markets.

Utility Holding Companies in the Early 1900s

The history of Allegheny Power is interwoven with the controversial history of utility holding companies in the United States. From the beginnings of centralized power generation in the 1880s, ownership of the nation's electric companies was concentrated increasingly in the hands of financiers such as J.P. Morgan and Samuel Insull. The power industry required more capital per dollar of operating revenue than any other business and thus became controlled in large part by a small number of men with intimate connections on Wall Street and in the banking community. The early power magnates found it useful to unite many small generating companies under the umbrella of a single holding company. Such a holding company, with a far larger asset base than any of its constituents, was more likely to impress investors as a reasonable gamble than were the individual companies, thus providing a means of generating the immense capital needed to expand in the power industry.

One of these holding companies was the New York-based American Water Works & Electric Company, which in the first decades of the 20th century began to acquire control of both water facilities and power plants in the northeastern part of the United States. Among the companies it controlled were the 53 Pennsylvania light and power companies that in 1916 had been united to form the West Penn Power Company. Included in the purchase of these small power companies was their former parent, West Penn Traction Company--later known as West Penn Railways--a minor operator of electric railways. West Penn Power served much of Pennsylvania's southwest corner, with the important exception of Pittsburgh proper, as well as a chunk of the state's north-central region and most of its border with Maryland. The company's generators were a mix of water turbines and coal-fired steam, the percentage of the latter growing rapidly as the area's electrical needs outstripped its limited hydroelectric capacity. Much of West Penn Power's revenue was derived from industrial sales, primarily to the region's iron, steel, and coal mining operations.

Another of American Water Works' major investments was Washington County Light & Power Company, based in Marietta, Ohio, but with most of its customers in neighboring West Virginia. Washington County served a predominantly rural area that, like West Penn's, was rich in both coal and in rivers suitable for hydroelectric damming. Farther to the east lay a number of electric companies amalgamated in 1923 into The Potomac Edison Company, doing most of its business in western Maryland along the Potomac River. Potomac Edison, like Washington County Light & Power, was a relatively small, rural electric system that also controlled several local bus lines and electric railways.

By assembling these three regional companies, American Water Works had succeeded in gaining control of the power generation in a sizable portion of land in five states. Nearly all of the plants involved were tiny, pioneering outfits that, given the economic and engineering realities of the utility industry, were certain one day to be unified in one form or another. In 1925 American Water Works took a second step toward doing so by consolidating all of its electrical, bus, rail, and natural gas companies under the name of West Penn Electric Company. West Penn Electric, a Maryland corporation, took charge of the three operating companies--West Penn Power, Washington County Light & Power, and Potomac Edison--and began the gradual integration of the system's complex array of power plants, transformers, and transmission lines. The area served by West Penn Electric's companies in 1925 was very nearly identical to that served by the Allegheny Power System in 1991; further expansion evidently was blocked by other, more powerful utilities busy consolidating their own holdings. West Penn Electric officially incorporated in 1925.

The Challenges of Independence: 1920-60

In the 1920s the formation of public utility holding companies reached its zenith. Amid growing public concern, people such as Samuel Insull put together enormous pyramids of interlocking corporations, many of them widely overcapitalized and all difficult to police with the existing regulatory resources. When the stock market crash of 1929 brought many of these holding companies to bankruptcy, thousands of stock and bond holders were ruined and the outcry prompted a series of congressional investigations of the power industry. In 1935 Congress enacted the Public Utility Holding Company Act, a comprehensive piece of legislation designed to restrict the concentration of ownership in the power industry to those instances where it clearly resulted in greater efficiency and lower consumer costs. In particular, power companies serving noncontiguous areas were not to be held in common ownership unless such benefits could be shown, which was not likely; hence, under the aegis of the Securities and Exchange Commission (SEC), a long series of dissolution proceedings was instituted against the leading utility holding companies.

Among the targets of the SEC was American Water Works & Electric Company. Although the latter's electric holdings under the direction of West Penn Electric were all within a single geographic area, American Water Works also owned water works in other parts of the country. The SEC objected to this arrangement and ordered American Water Works to propose a plan for segregation of its water and electric holdings, which was forwarded and accepted in January 1948. Under the American Water Works plan, equity in West Penn Electric owned by American Water Works would be distributed to American Water Works shareholders, the water works firms would be similarly spun off, and American Water Works itself would cease to exist. Accordingly, as of January 1948, West Penn Electric became the independent owner of its three operating companies, whose territories and facilities were not otherwise affected. West Penn Electric's headquarters remained in New York City.

The newly independent power company faced an ambiguous economic situation. Use of electricity was growing as never before, the U.S. postwar boom adding daily to the applications of electricity in the home and in the factory. Yet, the steel industry was moving away from Pittsburgh. Within a scant ten years the Pittsburgh area would lose its position as the world's leading steel center, and steel production provided West Penn Electric with the largest portion of its industrial sales. A third, even more crucial, factor was the price of fuel. In this respect, West Penn Electric was extremely fortunate. Since the earliest years of power generation, utilities in the eastern part of the country had been shifting from hydroelectric energy to coal-fired steam turbines, with capacity far greater than that offered by Appalachian rivers. West Penn Electric was located in the midst of one of the richest coal regions in the United States, which meant that its fuel costs would remain low as long as coal remained its primary fuel. West Penn Electric always had owned a number of minor coal deposits as an emergency reserve but for the most part had relied on long-term contracts with the region's large mining companies for its supply.

Guaranteed a secure and inexpensive source of fuel, West Penn Electric was able to compile an admirable record of unbroken growth in the postwar decades. With the exception of 1958, the company increased its dividend payments every year from 1948 to 1990. By the mid-1950s West Penn Electric had divested itself of all interests outside the utility business, selling off the various minor bus and rail lines inherited from the company's early years. The company also became interested in the newly emerging field of nuclear power, which it considered as an alternative energy source for the coming years despite its ready access to coal. West Penn Electric joined a number of other utilities in forming the East Central Nuclear Group to study further the possibilities of nuclear power, but in the end decided that the expense and risk inherent in nuclear generation could not be justified given the company's coal resources. West Penn Electric thus was spared the increasingly severe problems faced by the nuclear power industry. The company's total reliance on coal-fired plants, however, had left it vulnerable to national concern about acid rain and air pollution in general.

The Energy Crisis of the 1970s

In 1960 West Penn Electric adopted its present name of Allegheny Power System, Inc. Its three principal subsidiaries, then as in the early 1990s, were West Penn Power, Potomac Edison, and Monongahela Power, the latter formerly Washington County Light & Power. The 1960s continued the postwar trend toward a decreasing industrial revenue offset by general population growth and by increased per capita use of electricity. With the U.S. economy generally in robust health, Allegheny Power System faced few problems more serious than the occasional wind storm or system overload. This pleasant scenario changed abruptly in 1973, when the OPEC oil embargo changed forever the economics of energy. Almost overnight the price of coal tripled, a jump that would have spelled disaster for Allegheny if it had been forced to rely on the usual laborious procedure for rate adjustments. State and federal regulatory agencies, however, agreed to let Allegheny and most other utilities establish a special fuel index as part of their rate structure, passing on to the consumer such wholesale leaps in the cost of doing business. Despite the turmoil, Allegheny did not suffer any significant reverses.

In the early 1980s, Allegheny agreed to purchase 40 percent of the output of Virginia Electric and Power Company's pumped storage project, forming Allegheny Generating Company to act as its representative in the partnership. Pumped storage is a type of hydroelectric generation that adds to output capacity. The pumped storage project provided about ten percent of Allegheny's 1990 total of 7,991 megawatts of power, with the remainder generated almost entirely by coal.

Deregulation in the 1990s

In 1985 Klaus Bergman assumed the titles of president and chief executive at Allegheny, from which vantage he prepared for the difficulties awaiting the company in the 1990s, in particular the cost of compliance with the Clean Air Act Amendments of 1990. The new amendments were aimed squarely at owners of coal-fired generators such as Allegheny's operating companies, setting new, more stringent limits on sulfur dioxide emissions that were to become fully effective in the year 2000. Thus Allegheny faced the downside of its decision in the 1950s not to pursue nuclear power; with 90 percent of its electricity from coal, the company estimated that compliance with the new standards would cost as much as $2 billion. Allegheny planned to lower emissions by installing scrubbers&mdash≡uipment that cleans up the emissions from smoke stacks--at its coal plants, rather than abandoning its local suppliers of high-sulfur coal in favor of more distant sources of low-sulfur coal. The company concluded that scrubbers were more cost-effective in the long run and would obviate the need for fuel purchasing changes that would hurt the local economy.

Allegheny's focus shifted toward new opportunities in 1992, when the Energy Policy Act opened the door for deregulation of the nation's regional utilities. Pennsylvania became one of the first states to encourage competition in the energy business with the Electricity Generation Customer Choice and Competition Act of 1996. This new law declared that all customers in the state would be free to sign up with the power provider of their choice by January 1, 2001. In 1997 Allegheny Power Supply became Allegheny Energy, Inc. and formed a new subsidiary, Allegheny Energy Solutions, for the purpose of marketing electricity to a broader base of retail customers. That same year the company signed a deal to acquire Pennsylvania utility DQE for $10.6 billion. After the Pennsylvania Public Utilities Commission (PUC) ruled that Allegheny Energy would be responsible for two-thirds of its overall stranded costs after the transition to the competitive market, however, DQE elected to withdraw from the deal. Later that year the PUC approved a restructuring of West Penn Power Company, Allegheny's utility subsidiary in Pennsylvania. This agreement allowed Allegheny to offer two-thirds of its customers the right to choose their electricity providers beginning in January 1999. It also authorized the transfer of West Penn's generating capacity of 3,778 megawatts to Allegheny's new subsidiary, Allegheny Energy Supply, LLC, for sale in unregulated markets.

Allegheny Energy Supply was formed in November 1999. One of the new company's priorities was to diversify Allegheny's energy interests to include natural gas. This move not only opened up a wider range of opportunities for growth, but, more importantly, provided Allegheny with a means of making the transition to cleaner fuel alternatives. Although Allegheny had maintained strict compliance with the Clean Air Act Amendments throughout the decade, in 1999 almost 90 percent of its power generation still came from coal-burning generators. At the end of 1999 Allegheny finally became a player in the natural gas industry with the purchase of West Virginia Power. The deal gave Allegheny 26,000 new electricity customers and 24,000 new natural gas customers. In 2000 the company announced its plan to acquire Mountaineer Gas Company, adding an additional 200,000 natural gas customers.

The year 2000 was one of significant growth for Allegheny Energy. In August the company transferred Potomac Edison's generating assets from three states into Allegheny Energy Supply, increasing its unregulated megawatt capacity by 2,100. This transaction gave Allegheny Energy Supply more than half of the company's total electricity. In November the company expanded its natural gas holdings, as well as its geographical scope, with the purchase of three natural gas-fired generators in Tennessee, Indiana, and Illinois. This followed the announcement in October that the company planned to build a 1,080-megawatt capacity natural gas generator outside of Phoenix, Arizona, with construction scheduled to begin in 2002. Closer to home, the company also began building a 540-megawatt combined-cycle generating plant in Springdale, Pennsylvania. The new plant featured two gas-fired turbines and one steam turbine and was expected to be operational by 2003. This diversification of the company's holdings, along with its plans to introduce competition into the Ohio and Virginia markets in 2001 and 2002, has placed Allegheny in a leadership position in the deregulated energy industry.

Principal Subsidiaries: Allegheny Energy Supply LLC; Allegheny Power; Allegheny Ventures; Allegheny Energy SVC Corp.; Allegheny Energy Solutions; Allegheny Communications Connect; Monongahela Power Company; The Potomac Edison Company; West Penn Power Company; Allegheny Generating Company.

Principal Competitors: American Electric Power Company, Inc.; DQE, Inc.; PPL Corporation.

Chronology

• Key Dates:

• 1916: American Water Works & Electric Co. creates West Penn Power Company.
• 1923: Potomac Edison is formed.
• 1925: West Penn Electric Company is incorporated.
• 1948: West Penn Electric assumes independent ownership of its operating companies.
• 1960: West Penn Electric is renamed Allegheny Power System, Inc.
• 1985: Klaus Bergman becomes president and CEO.
• 1992: Energy Policy Act inaugurates age of deregulation.
• 1997: Allegheny Power System is reorganized as Allegheny Energy, Inc.
• 1998: Pennsylvania Public Utility Commission approves restructuring of West Penn Power Company.
• 1999: Allegheny Energy Supply, LLC is formed.