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NYSEG PLAN TO ACHIEVE PRICE STABILITY HAS LOTS OF APPEAL

New York State Electric & Gas Corp. and Niagara Mohawk are taking very different paths along the road to the promised land of a truly competitive electric market.

Never was that more apparent than last week, when NYSEG's parent company agreed to pay $2.4 billion to buy RGS Energy Group in a deal that will add Rochester Gas & Electric to its New York service territory and create a utility that serves half of upstate New York.

The deal reaffirmed NYSEG's hybrid approach to deregulation, one that favors predictable rates and, with the addition of RG&E's 1,000 megawatts of generating capacity, also places a renewed emphasis on owning power plants that can meet a significant portion of its electricity needs.

"This transition to a fully competitive energy market is going to take a long time and we don't want our customers exposed to a lot of bumps," says Wes von Schack, Energy East's chairman, president and chief executive officer.

That's a big reason why Energy East executives are using their offer to freeze power costs through 2008 as the big carrot to help it win approval from state regulators. Between its power plants and long-term contracts to buy electricity from other suppliers, NYSEG says it can ensure stable prices for its customers.

"This whole thing is one big experiment and our customers are in the middle," von Schack says. "We're in position to do something about this while we go through this experiment."

Contrast that with the more conventional, open market approach that's being followed by Niagara Mohawk and most other New York utilities, who are selling their power plants and focusing solely on running the power lines and transmission system that delivers the electricity to customers.

Niagara Mohawk is promising to cut delivery charges to its residential customers by nearly 8 percent as part of what National Grid USA President Richard P. Sergal calls the "dowry" for winning approval for its British parent company's $8.9 billion bid to buy NiMo.

But NiMo's rates are structured differently than NYSEG's, with a customer's total bill split between the delivery charges that the company wants to reduce and the actual price of the electricity itself, which is determined by the commodity market and purchasing strategies. And in the coming years, NiMo's long-term supply contracts will gradually begin to expire, meaning more of its electricity costs will be based on market prices.

So even with the lower delivery charges, NiMo's residential consumers still can expect their total bills to rise by about 6 percent because the price of the electricity itself has soared.

"It's important that the commodity price be reflected through," Sergal said earlier this month during a stop in Buffalo. The lower delivery charges "will go a long way toward reducing the increase in the commodity price."

Which approach is better? Only time will tell, but for now, with the nation's electricity markets in a whirl over deregulation and warnings that power supplies are getting dangerously tight, the NYSEG approach has a lot of appeal.

Yet if more power plants are built in the next few years and a more adequate supply of electricity hits the open market, electricity prices could drop. That would help NiMo customers, whose electricity costs gradually will be linked more closely with activity on the wholesale power market.

"If there's lots of supply and lots of bidding, the customer is going to benefit because commodity prices will come down," Sergal says.

Still, all the uncertainty swirling over the electric industry has Energy East headed down a road less traveled by New York's utilities.

"The secret here is to maintain your flexibility. The resolution of this process is going to be longer and rockier than originally thought," says Thomas Richards, RGS Energy's chairman, president and chief executive officer. "One of the things the last couple of years has shown is that you've got to live long enough to get there."

To do that, Energy East executives, who have sold off most of NYSEG's power plants over the last three years, decided that owning your own power plants can be a big help, even though their long-term goal is to ultimately become a "pipes and wires" company, just like NiMo.

That's one reason why the company agreed to buy RGS Energy, which brings with it about 1,000 megawatts of generating capacity, including the Ginna nuclear power plant outside Rochester.

That means a big chunk of the company's electricity needs can be met in-house, giving it more predictable energy costs and reducing the amount of power it needs to buy on the open market. NYSEG also is interested in building some smaller generating facilities that would be used to augment power supplies during times of peak demand, von Schack says.

"Our ability to bring generation to this pricing mechanism is very important," Richards says.

"We think having these generating assets for the foreseeable future is a valuable way of seeing us through this transition," he says. "It's clearly a valuable asset to maintaining rate stability in upstate New York."

NiMo, however, is headed down the opposite path. National Grid's roots are in the power transmission business, and that's where its focus will stay. Its goal is to keep NiMo's transmission and delivery charges below the regional average and let power generators and the free market worry about electricity prices.

"We don't want to be in the generation business," Sergal says. "We don't want the conflicts that go with that."

Yet the companies have some things in common, too.

Both companies are caught up in the wave of consolidation that's been sweeping through the electric utility industry for the last six years. Size is becoming an ever more important factor, with some analysts saying transmission companies need at least 2.5 million customers to be competitive.

That's why National Grid turned to Niagara Mohawk, whose own weak finances precluded it from making the acquisitions it needed to gain that critical mass. Combining Niagara Mohawk with National Grid will create a company with 3.2 million electric customers and 540,000 gas customers.

Likewise, the Energy East deal will create a company with nearly 2.8 million customers, including 1.8 million electricity customers and more than 900,000 on the natural gas side.

"In order to be successful in this environment, you've got to have some size," RGS' Richards says.

And Energy East, which has made four other acquisitions during the last two years to stretch its customer base into New England, is giving every indication that it intends to be a survivor now that the RGS deal makes it one of the Northeast's biggest energy providers.

"It gives us the scale and scope to better compete," von Schack says.

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