Fire, Ice and Free Markets

Remarks to the Chief Executives’ Club of Boston
January 30, 2003
Rick Priory
Chairman and CEO
Duke Energy

Thank you, Ted for your kind introduction. I am particularly delighted to be here today—delighted indeed—in view of what I have been doing over the last few days. Two days ago, Duke Energy announced its 2002 year-end earnings, and I’ve been spending a little quality time with investors and financial analysts discussing those results! If your 2002 was anything like mine, you can appreciate how good it feels to be on the harbor among friends!

I know the Chief Executives Club of Boston is renowned for attracting members who are leaders, doers and forward thinkers. If your group keeps count of business leaders who hail from this area, you ought to claim another in Tom O’Connor, who is here today.

Tom was recently named president of Duke Energy’s Gas Transmission business, where he is responsible for our $18 billion pipeline business in the U.S. and Canada. While Tom is now based in Houston, he is a native of Lawrence and began his energy career with Algonquin Gas here in Boston. Tom is an alumnus of U Mass-Lowell and an avid follower of the Patriots, Bruins, Celtics and Red Sox.

It is also a pleasure to be here among customers. In New England, Duke Energy participates in the wholesale energy market. We sell our products and services to companies like Keyspan and NStar that serve the natural gas and electricity needs of retail customers.

As Ted mentioned, Duke Energy has a significant presence in Massachusetts, and we’re investing more. We operate two major natural gas pipelines here:

• The Algonquin Gas Transmission Company, which is approaching its 50th anniversary, operates more than 400 miles of pipeline in the state.
• And the Maritimes & Northeast Pipeline, which has operated in Massachusetts since 1999.

Together, the two pipelines provide more than 50 percent of the natural gas delivered to New England—and the Greater Boston area is their primary market

Both pipelines have expansion projects underway, representing an investment of more than $300 million.

In addition, next week we will file an application with the Federal Energy Regulatory Commission for the Everett Extension Project, which represents another $100 million investment in Massachusetts.

Duke Energy isn’t the only company building energy infrastructure in New England. Ten thousand megawatts of new electric generation—more than 20 new plants—have come on-line, are under construction or on the drawing board. The majority of that new generation will be fueled by natural gas. And the new power plants coming on line are significantly cleaner and more efficient than older plants.

The level of energy investment and abundant supply available in this state—whether pipelines or power plants—is a direct result of the Commonwealth’s wisely constructed electric restructuring model.

While California continues to suffer the consequences of its flawed plan, you’re doing it right—and realizing the benefits.

Massachusetts has streamlined the power plant permitting process, closing the time gap between power price signals and supply. Your plan encourages long-term wholesale contracts, effectively managing risk for energy customers. And your plan includes an important level of regulatory flexibility, allowing transitional pricing via fuel clauses to reflect actual market conditions.

You’ve realized the benefits of cleaner and more efficient power generation—and you’re enjoying the price effects of deregulation as well:

• Electric consumers in Massachusetts have realized $1.7 billion in cumulative savings through December 2000, from a combination of rate reductions and net revenues from the sale of generating plants.
• From 1996 to 2001, average residential electricity prices in the state have decreased almost 6 percent, commercial sector prices have fallen more than 12 percent, and industrial prices are down more than 7 percent. That is the emerging promise of competitive energy markets.

The competitive forces of energy are working well in Massachusetts—even at a time when all other forces of the universe seem to pushing hard against business and economic order! Which brings to me to two key points I’ll address today:

• First—my belief in the promise and resiliency of competitive markets.
• Second—a fully functioning competitive energy market is critical to economic recovery and sustainability.

* * * * *

I am a strong and unbending advocate of free markets. I believe in the ability of our country’s markets to evolve and adapt and serve the needs of society.

And while the blaze of corporate scandal—sparked by Enron and fanned by Worldcom, IMClone and far too many more—spread with a vengeance last year, the marketplace will survive. It will even thrive—in spite of the meddling and mucking up we bring to the recovery process, all in the name of reform, restraint, and risk avoidance.

Standing this close to the flames, it’s hard to see beyond the collateral damage of the last 12 months: Billions in lost capital. Retirement savings ravaged. Charred reputations. And the immeasurable loss of investor confidence and public trust.

But the evolutionary nature of markets is like that of a forest that relies on lightning strikes and cyclical fire to clear brush, remove tinder, and open the canopy to healthy sunlight. In my home state of North Carolina, fire is a valued management tool for protecting our state tree—the longleaf pine. The immediate aftermath of a burn isn’t a pretty sight—but the long-term effect is a hardier, healthier and more resilient ecosystem.

Economies and ecology have more in common than we often think. Sixty years ago, economist Joseph Schumpeter, who studied and taught across the river at Harvard, dubbed the notion “creative destruction.” His theory was that the evolution of free markets was constant—but it wasn’t steady or discreet. Creative destruction, he wrote “revolutionizes the economic structure from within, destroying the old one and creating a new one.”

As leaders of business, we were close to the fire last year. Much of the heat that came our way felt misdirected and undeserved.

Allegations of misconduct cast a long shadow of suspicion across all of corporate America. People remember the $15,000 umbrella stand—and the sheer excess it symbolized. They recall, with unsettling clarity, Senate subcommittee appearances; the cost of a megawatt hour during California’s energy crisis; and the grim faces of the newly unemployed, exiting corporate towers with their careers packed in brown file boxes. Powerful symbols and perceptions that are easy to transfer and hard to shake.

But behind the headlines and symbols and hand-wringing—our market system worked. It rooted out excess and deception, and punished those who would unfairly game the system. It punctured the bubble of unsustainable expectations, and it leveled the field.

* * * * *

If there was heat from last year’s firestorm, there was also light—and important lessons. Here are a few that top my list:

First, last and foremost: integrity is the foundation of business success. The asset of integrity isn’t a feel-good notion void of relevance or substance. Integrity carries real weight and real value—and is the one true and enduring measure of a company.

We all witnessed the market’s painful doling out of punishment for corporate transgression and individual greed last year. And while there were few rich rewards in last year’s bear market, companies that built upon the tenets of fair play and sound ethics are with us today—and they’ll be here tomorrow. Investors, customers and good employees are drawn to companies that operate by the principles of integrity, trust, and respect.

Second lesson: you can’t build a firewall when flames are lapping at your heels. While trust can be lost quickly, it takes a far longer time to rebuild and recover. Regrettably, in some companies the focus on ethics has been too late—or too light.

Values and ethical standards can be printed, embossed or tattooed. But to be truly effective, they have to be wired deeply into an organization, defining a company’s culture and guiding its decisions and actions. They have to be owned, not by the PR department and certainly not just by the CEO, but they must be owned by every employee at every level and every location.

Third lesson—take a longer view of value: As a society and marketplace we had become fixated on short-term returns and immediate gratification.

Analysts and money managers focused too closely on a company’s quarterly performance. A company’s strategy, plans and outlook were cast aside in favor of the “McQuarter” report—super-sized and served up with a side of beat-the-street fries! Shareowners moved from the mindset of investors to the outlook of Wild West speculators.

We all—investors, analysts, and businesses—we all need to take a longer view of value and face the reality that stratospheric short-term results are not sustainable and they’re not healthy.

Fourth lesson: Businesses must take the lead to promote reform and restore investor trust. And I believe we’re doing that. In fact, the pace at which we’re correcting our course is compelling proof of the market’s inherent ability to respond to all disruptions. Our moves to increase disclosures, reduce debt, improve liquidity and put into place effective new governance measures are critical to long-term recovery.

Two quick examples from my industry: The Electric Power Supply Association developed a Code of Ethics for electric power suppliers that is being adopted across our industry.

And last year, Duke Energy became a founding member of the Committee of Chief Risk Officers, an active coalition of more than 30 companies engaged in energy trading. The Committee is working to develop best practices and consistent reporting standards to make the energy trading business easier to understand and compare.

America’s business community and its market systems stand at an important crossroad. The lingering smoke from last year’s fires reminds us of the gray that surrounds black and white business decisions. Our job is to remove the gray areas and clear the air. We must be proactive in making our earnings more visible, our financial reporting more transparent, and the characterization of our business clearer than ever.

* * * * *

From the fires of last year, let me turn now to the winter ice storm that affected our regulated electric utility and others in the Carolinas.

In December, nearly 1.4 million households and businesses in our service territory were left without power in the most devastating ice storm of our company’s history. After the year we just suffered through, it felt like a final crushing insult delivered by Mother Nature. But it proved to be an important reminder of our collective reliance on what is ultimately delivered through our country’s pipes and power lines: Warmth. Light. Comfort. Convenience. Efficiency. Productivity.

For me, the ice storm was a compelling symbol of the vital, visceral nature of our work. Our line crew workers left their homes and families to serve the needs of neighbors they may never know. Employees across our company volunteered to staff the phones of our Customer Service Center. Two of our line technicians were on their way to a job when they saw flames and smoke coming out of a house. They went in and rescued an elderly couple. While recent rhetoric may make it seem otherwise, there are real heroes in business doing important work—and the generation and delivery of energy is important work.

I mentioned I had two key points today, and here’s the second: Energy is critical to economic recovery.

Consider this fact: Since 1973, growth in electricity use has almost exactly matched growth in real U.S. GDP.

Energy and economic interdependence works both ways. Prolonged high energy prices can dampen economic growth. The last three recession periods in the U.S. were preceded by spikes in the price of oil. Abnormally high energy prices adversely affect business operations, corporate budgets, consumer confidence and spending.

On the flip side of that, reliable, reasonably-priced power supplies can invigorate economies, spur growth, unlock new markets and foster innovation. That was the promise of the Energy Policy Act of 1992 that set into motion the restructuring of electric power markets—a promise that is being realized here in Massachusetts.

But there are some who would have us renege on the promise of competitive energy markets, pointing to the debacle in California as evidence of fatal market flaws.

In my view, placing the blame on competitive markets is ill-advised and way off-mark. Kinks in the system don’t arise from free and open markets—they come about when there’s not enough competition—when competition is constrained—or when the transition to competition is twisted or curtailed.

If we truly want the benefits of electric deregulation, we’ve got to let price signals work. We need to give our markets the time and the latitude to expand and contract and correct themselves. And we must resist the urge to stifle the occasional brush fire by sucking all of the oxygen out of the marketplace.

Vernon Smith, the winner of this year’s Nobel Prize in Economics, observed that the past decade has been “a case study on the perils of limiting competition and distorting market incentives.”

Government intervention distorts and impairs market activity. But indecision and inaction don’t work either. Clearly defined and consistently enforced rules are a necessary pre-condition for the creation of healthy energy markets. We need to proactively address market flaws—rather than responding with price caps and mitigation that mask market signals and discourage new investment.

Two years ago, there was great concern about a pending shortfall of electric supply. Thanks to the incentives of a competitive market, that situation has been corrected—over-corrected from our standpoint. But still, the current supply situation should actually symbolize the great value—and the greater good—that energy has brought to every segment of the American economy. We have deployed unprecedented amounts of capital at an incredible pace to launch the most impressive construction boom in the history of power generation.

We have catapulted the domestic economy from the brink of energy shortages. And now—just when we’re poised to deliver even more benefits to the marketplace, we’re facing the possibility that the whole vehicle—competitive markets—could be thrown into park—or worse yet—reverse—when what we need most is forward momentum.

Competitive markets—in your business and in mine—provide the checks and balances needed for long-term stability. They promote innovation, creativity, a constant stream of new market participants, price discovery and attendant efficiencies.

Competitive markets are also amazingly self-correcting. Even when competitive change leads to market disruptions, the disruption ultimately results in marketplace improvements and a focus on the fundamentals of serving customers. Which brings us back to Schumpeter’s “creative destruction,” the ecology of fire, and the clarity of purpose that comes with an ice storm.

I am confident in the resilience of our markets and in the future of competitive wholesale energy markets. And I am confident that out of the ashes of last year’s crisis in confidence we will see tremendous strides forward in corporate accountability, governance, financial reporting and transparency.

Thank you.