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The AES Corporation

The AES Corporation

1001 N. 19th St.
Arlington, Virginia 22209
(703) 522-1315
Fax: (703) 528-4510

Public Company
Incorporated: 1981 as Applied Engineering Services, Inc.
Employees: 1,435
Sales: $520 million
Stock Exchanges: NASDAQ
SICs: 4911 Electric Services

One of the largest and fastest growing independent power producers in the United States, The AES Corporation is a builder, owner, and operator of power plants around the world. In the early 1990s AES operated seven power plants in the United States, was conducting activities in 17 foreign nations, and was rapidly expanding into China, India, and several other thriving power markets.

A relatively young company, AES was formed after federal legislation enacted in the late 1970s opened the door to privatized power generating facilities. The industry-renowned Public Utilities Regulation Policies Act (PURPA), passed by Congress in 1978, was originally intended to reduce U.S. utilities reliance on oil. However, it actually prompted a healthy market for nonutility power generators (NUGs) like AES.

Between the 1930s and the late 1970s, production, transmission, and distribution of electric power was relegated exclusively to vertically integrated, monopolistic utilities. The industry operated under the guidelines of the Public Utility Holding Company Act (PUHCA) of 1935, which essentially barred independents from participating in the generation (and distribution) of power. When the oil crises of the late 1970s arose, however, PURPA was passed as a means of encouraging smaller companies to create and sell alternative (non-oil generated) forms of power to the utilities. In many cases, utilities were required by federal law to purchase power from these new qualifying facilities, or NUGs.

Two members of the Nixon administrations Federal Energy Administration were Roger Sant and Dennis Bakke. In the years leading up to the passage of PURPA, Sant, who also lectured at Stanford Universitys business school, was in charge of energy conservation and the environment, while Bakke, a recent graduate of Harvards business school, served as Sants deputy. Following the passage of PURPA, Bakke and Sant teamed up in 1981 to form a consulting firm, Applied Engineering Services, Inc., that advised utilities on low-cost energy planning.

Through their consulting experiences, the two entrepreneurs quickly realized that a much more lucrative niche existed for companies that could generate high-volume, low-cost power for sale to utilities and large power consumers. By drawing on Americas vast and stable coal reserves, an efficient independent could undercut large power producers and reap significant returns. Also, in addition to federal mandates abetting the independents, private coal-fired plants would not be subject to the binding state rate regulations that fettered established utilities.

Under PURPA, AESs facilities would have to meet at least one of two specified conditions: they would have to generate less than 80 megawatts of power, a small amount in comparison to some large utility generators; or, each facility would be required to sell both steam and power, a process referred to as cogeneration. By developing large-scale cogeneration plants, Sant and Bakke determined that they could undercut the competition and still capture sizable profits, despite being susceptible to federal price controls.

AES started its power plant building operation in December of 1983. Unable to finance the construction of an entire power generating facility, the company utilized an arrangement similar to that used by real estate developers. It had only limited ownership (and liability) in the project and garnered funding from outside investors. AES also borrowed against long-term contracts to supply utilities with power. Besides its ownership share, AES received compensation for developing and managing the project.

The companys first cogeneration facility, Deepwater, began selling power in June of 1986. Located in Houston, Deepwater was a petroleum coke-fired power plant capable of generating 140 megawatts of power. AES sold Deepwaters electricity to Houston Lighting and Power, the citys state-regulated utility, and an adjacent petrochemical refinery bought the residual steam to help power its operations. Although AES retained a relatively meager ownership interest in the plant, Deepwater provided valuable experience for Sant, the companys CEO, and Bakke, who served as president and chief operating officer.

Even before Deepwater was in operation, AES initiated two other major projects. Begun in September of 1985, the Beaver Valley gas-fired cogeneration facility near Pittsburgh began selling its power in July of 1987. AES was able to sell the electricity from the 120-megawatt plant to West Penn Power, and the steam byproduct was consumed by nearby Arco Chemical. The companys Placerita plant, located in Newhall, California, was also a 120-megawatt plant, but it was powered by natural gas. Started in 1986 and finished in August of 1988, Placerita sold its electricity to Southern California Edison.

By 1989 AES had three facilities up and running, had started construction on two more, and was working to secure financing for several other projects. Furthermore, in the five years that the company had been involved in developing cogeneration facilities, it had boosted its annual revenues to $99 million and swelled its assets to a whopping $861 million. While net income reached only $4 million, future profit expectations were extremely positivein fact, net income bounded to $16 million in 1990 and $43 million in 1991.

AES success at attracting funding and customers for its cogeneration projects reflected the overall success of post-PURPA NUGs that were springing up around the nation during the early to mid-1980s. On average, NUGs were generating between 15 and 17 percent returns on invested capital, versus only ten to 12 percent returns for traditional state regulated utilities. As a result, the independent power producers flourished. By the mid-1980s, in fact, the NUGs were building more power generation capacity than the entire U.S. utility industry, and while AES benefitted from generally positive industry trends, the company also outperformed its competitors during the 1980s.

Sant and Bakke attributed much of the companys stellar growth to its unique management structure and style. To the amusement and dismay of some analysts, AES employees held four shared values: integrity, fairness, fun, and social responsibility. At one point, the Securities and Exchange Commission wanted to identify the values as an investment risk factor. As stated in the companys prospectus, AES desires that people employed by the company and those people with whom the company interacts have fun in their work. [The companys] goal has been to create and maintain an environment where each person can flourish in the use of his or her gifts and skills and thereby enjoy the time spent at AES.

While some observers snickered at AESs management philosophy, workers took it seriously and the company seemed to be profiting from its unorthodox approach. AES empowered its workers to make most of the day-to-day decisions at its plants, and it organized its labor force into small teams that cooperated to accomplish specific tasks. Its plants had no shift or maintenance supervisors, no personnel department, and almost no middle-level managers or administrators. Workers were hired only after completing a five-step interviewing process that stressed attitudes and values, rather than technical ability. Finally, incentive-based compensation was an integral element of the AES employment creed. In this organization you dont give orders and have them filter down. Its the opposite of that, explained Dave McMillen, plant manager for AES, in The Washington Post. In this culture, a manager gets his fun from seeing other people succeed.

Sticking with its management style and strategy of growth through development of new cogeneration facilities, AES brought two new plants on line in the early 1990s. Its coal-fired Thames plant in Montville, Connecticut, opened in March of 1990 and began providing a full 180 megawatts of power to Connecticut Light & Power, while selling steam to Stone Container Corp. Not quite a year later, AES opened one of the largest cogeneration facilities in North America, the Shady Point plant in Poteau, Oklahoma. Another coal-fired enterprise, the plant generated an enormous 320 megawatts of power for sale to Oklahoma G&E.

AES had experienced an overall high level of success with its plantsassets had grown to almost $1.4 billion by 1991, sales had reached $334 million, and total power capacity was at 860 megawatts. However, Sant and Bakke as well as many other independent power industry executives began to question the future viability of the U.S. cogeneration market. In addition to frustrating regulatory requirements that obstructed success in the industry, AES and its competitors were under increasing pressure from government and special interest groups to reduce pollution.

Although AES pointed out that its environmental record was almost beyond reproach, critics of its plants argued that coal-fired generation facilities were a detriment to the environment. The company encountered heated oppositionmostly from local residentsto proposed cogeneration projects in several states, which resulted in substantial losses. In Maine, AES lost $5 million when it had to abandon plans for a facility near the Penobscot River; environmentalists complained that the plant would ruin the river bank. Also, community opposition caused the company to walk away from a plant in Florida that was partially completed.

Given their admirable record of public service and sensitivity to the environment, Sant and Bakke were frustrated by allegations of environmental negligence. Sant, for example, sat on the boards of four environmental organizations in the early 1990s, including the World Wildlife Fund and the Environmental Defense Fund. The company gave the Nature Conservancy a donation sufficient to purchase a rain forest in Paraguay that was large enough to offset the emissions from its Deepwater plant. In 1989 AES also funded a program in Guatemala to plant 52 million trees by the year 2000 in order to offset emissions from its Connecticut plant. The company really does seem to have a corporate culture that values the environment, a lobbyist for Environmental Action commented in The Washington Post.

In addition to environmental problems, AES experienced setbacks in some of its operations during the early 1990s. The companys Houston facility, for example, was near bankruptcy in 1991, unable to meet payments on its loans; AES was stung by falling natural gas prices, which were used to determine the contract price that the utility had to pay for the power it got from the plant. Worse yet, in 1992 AES revealed that employees at its Oklahoma plant had falsified environmental reports given to the Environmental Protection Agency (EPA). Shareholders filed embarrassing class action suits related to that and a similar incident in Florida. Its as if 11 years of near-perfection are being forgotten because of two unfortunate incidents in a very short period of time, lamented Sant in The Washington Post.

Despite these problems, however, AES continued to realize steady and rapid growth during the early 1990s. In 1992 the company opened its sixth U.S. facilitya 180-megawatt, coal-fired plant in Oahu, Hawaiiand that year earnings jumped 31 percent to $56 million from sales of $401 million. Likewise, the companys asset base increased to more than $1.5 billion. Furthermore, AES was beginning to augment its efforts in the increasingly treacherous U.S. market with aggressive expansion overseas. In fact, in June of 1992 AES opened a huge 520-megawatt coal/gas cogeneration facility and a 240-megawatt coal-fired plant, both of which were located in Northern Ireland. The company also began constructing a massive 660-megawatt gas-fired generator in the United Kingdom.

However, the three European plants were just minor experiments compared to the ambitious international agenda being formulated by AES management going into the mid-1990s. For instance, AES planned to take control of a giant 650-megawatt coal/gas/oil generation facility in Buenos Aires, Argentina, in 1993. By that time the company had also raised over $1 billion to build at least three more plants in Great Britain that would deliver 1,500 megawatts. Most importantly, Sant and Bakke had big plans for China and India, which they believed would require three times as much new generating capacity as the United States by 2003.

AES was backing its Asian projections with action in 1993. A separately traded subsidiary, AES China Generating Co. Ltd., was created to concentrate solely on developing Chinese projects. AES also was actively pursuing a range of new projects in both China and Pakistan. Likewise, new projects were in the works in Italy, Peru, Singapore, Latin America, and former Eastern Bloc countries. AES expected to garner returns as much as two times greater than those available domestically, partially to compensate for increased risk related to investing overseas. Were probably spending 90 percent of our development capacity outside the United States, Sant estimated in Forbes.

Despite the companys heavy emphasis on overseas markets in the mid-1990s, AES was also banking on strong domestic growth through the turn of the century. Government estimates indicated that about 120,000 additional megawatts of capacity would be required by the U.S. power generation industry by the end of the 1990s, while 30,000 megawatts of existing capacity would need to be replaced. Furthermore, proposed changes to PUHCA that would favor independent cogenerators could substantially boost the share of the new capacity supplied by companies like AES.

Meanwhile, AES continued to boost earnings and assets in the mid-1990s. Sales jumped to $519 million in 1993 as profits climbed to $71 million, an impressive 27 percent gain. Total company assets reached $1.7 billion. In addition, at least one respected analyst predicted the companys earnings would grow at a ten to 15 percent clip through 1995, and at a rate of 15 to 20 percent through the end of the decade. Although unexpected environmental legislation or global political instability, among other factors, could significantly diminish these projections, AES management remained optimistic.

Principal Subsidiaries:

AES Barbers Point, Inc.; AES Beaver Valley, Inc.; AES Deepwater, Inc.; AES China Generating Co. Ltd.; AES Electric, Ltd. (United Kingdom); AES Shady Point, Inc.; AES Thames, Inc.

Further Reading:

Abrahms, Doug, AES Corp. Plans Public Stock Offering, Washington Business Journal, May 20, 1991, Sec. 1, p. 3.

The AES Corporation, Arlington, VA: AES Corp., 1993.

Crittenden, Ann, Generating Competition; Electric Utilities Face a Host of New Rivals, Barrens, February 3, 1992, pp. 14-15.

Cropper, Carol M., A Four-Letter Dirty Word, Forbes, January 17, 1994, p. 83.

Egan, John, Power Plays; Power Generators AES and Destec are Growing Fast, But Some Doubters Remain, Financial World, February 4, 1992, pp. 28-29.

Hamilton, Martha, AES Forms Subsidiary, Declares Stock Split, The Washington Post, December 18, 1993.

Hinden, Stan, Power Plant Firms Stock Sale Could Generate Big Profits, The Washington Post, June 24, 1991, Sec. E, p. 33.

Kripalani, Manjeet, Electric Utilities, Forbes, January 3, 1994, pp. 134-136.

, Speculative Utilities, Forbes, October 26, 1992, p. 234.

Prakash, Snigda, Independent Power Producer Gets Contract to Supply Utility, The Washington Post, February 3, 1992, Sec. 2, p. 7.

Southerland, Daniel, AES Sees Powerful Opportunity Overseas, The Washington Post, June 7, 1993, Sec. E, p. 1.

Tessier, Marie, Power Plant Builder Tries to Reenergize Environmental Image, The Washington Post, July 6, 1992, Sec. E, p. 1.

Dave Mote

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