Stanford GSB 1980 classmate Marc Vallen spent his entire career in the energy industry (with jobs in the natural gas, petroleum, and electricity sectors), during a time when all sectors experienced massive upheaval and restructuring. The market inefficiencies that occurred amidst this turmoil created unexpected career moves, which surprised him by providing unsought entrepreneurial opportunities. Here, he shares his experiences, and how, although he thought of himself as a dyed-in-the-wool corporate employee, he took advantage of some of those entrepreneurial opportunities.
Trading Energy Futures
After graduating from Stanford GSB, I joined Atlantic Richfield Company (“ARCO”) which, at that time, was a Fortune 12 company and where I expected to spend my entire corporate career. (Was I ever wrong.) Just before we graduated from Stanford in 1980, President Reagan deregulated the petroleum industry by deregulating the well-head price of crude oil. As with many of these deregulation measures, the full impact of the initial deregulation move was not fully appreciated until much later. When I, along with a couple of Stanford classmates and several other business school graduates, arrived at ARCO, much of the “old guard” was still trying to understand what it meant to have a market where crude oil freely traded and where the market itself determined the prevailing price, rather than filling out paperwork and having the regulations dictate the price that month for crude oil.
While this transition from regulation to free-market provided some amusement on the part of the new B-school hires, it was a few years before the full effects of free-market pricing in the spot market became evident. At that point, rather than purchasing crude oil under long-term contracts at fixed pricing, the industry moved to monthly, then daily, then hourly pricing. And then my first entrepreneurial opportunity appeared, surprisingly within the confines of a major corporation.
At a meeting one day, the Senior Vice President for the refining division asked if anyone knew anything about the futures market. This, of course, was the equivalent of a military request asking for volunteers and everyone except me taking one step back. I raised my hand and said I that had taken a futures course in graduate school. So yours truly became the instant expert on petroleum futures and, after a months-long process of researching and obtaining board approval, I became the first employee in a major oil company to trade energy futures.
Missing Out On Easy Pickings
A couple of years after I began trading both energy futures and “wet” barrels (i.e., the actual commodity in the spot market), ARCO, as well as many of the other integrated oil companies, imploded due to low spot market prices for petroleum. At that point, I left and became head of strategic planning for San Diego Gas & Electric Company (“SDG&E”), responsible for the strategic direction of both the traditional regulated and the growing unregulated sides of the business.
I was still learning more about the electricity industry when the first true entrepreneurial opportunity arose, but I was too tentative and missed it. Back in 1978, Congress passed the Public Utility Regulatory Policies Act (“PURPA”), which ultimately led years later to the deregulation of much of the electric generation business. PURPA required that the local utilities purchase electricity from any unregulated generators meeting certain criteria, and that the purchase price paid was to be at “avoided cost,” i.e., at the cost the local utilities would have paid had they generated the power on their own. PURPA left the determination of avoided cost up to each state public regulatory commission. Thus, determining the appropriate avoided cost price level at which the utilities were obligated to buy back electricity became a regulatory nightmare where the local utilities had to arm-wrestle with the state regulators to establish the avoided cost rates.
The early effects of PURPA were starting to show when I arrived at SDG&E in 1985. Early on, there were a number of these PURPA contracts between independent generators and the three main California utilities that were at avoided cost prices set so high that any proposal to build a generator and sell the electricity back to the local utility became incredibly lucrative. Unfortunately, I was still too new to the industry to appreciate the easy pickings available. But this highlighted an interesting opportunity that I followed throughout the rest of my career: whenever a regulator restructured an industry to respond to competition, market inefficiencies would surely follow in the early years of implementation.
Getting In and Out Ahead of the Big Players
At SDG&E, my responsibilities included researching deregulation trends and developing new customer products and services, which led directly to my next job and the entrepreneurial opportunities still to come in the deregulating electricity industry. I left SDG&E to join a boutique consulting firm in Chicago called Palmer Bellevue. Palmer Bellevue specialized in strategic assignments to assist utility managements in navigating the path from regulation to deregulation. We used these strategic consulting assignments to pay our monthly bills, but made our big money by starting small businesses to take advantage of the market imperfections our research uncovered.
At Palmer Bellevue, I started and ran a couple of marketing and energy conservation small business ventures.
The first venture was a joint effort with a large industrial controls manufacturer where we would bid for utility rebates to install energy efficient measures (a great example of a market imperfection) that we would use to subsidize energy efficient lights and controls at hospitals and schools. The second was a load curtailment effort in Chicago, where we organized a large group of commercial and industrial customers to curtail electricity consumption on the hottest days so the local utility could avoid the need to build a new generation unit to meet peak demand.
Both of these ventures were relatively short-lived, but they illustrated how a nimble, small business could be very lucrative in capturing market inefficiencies in the electric utility business, even short-lived ones. The key appeared to be able to respond quickly to opportunities and to exit the business before the big industry players moved in to dominate the market.
Running With, Then Into, Head Winds
In 1997, two colleagues and I left Palmer Bellevue to establish our own boutique consulting firm, CornerStone Energy Advisors.
As the electric generation business continued to deregulate, CornerStone specialized in two areas that were either starved for qualified personnel or very inefficient. One area of our specialization was focusing on identifying new (“greenfield”) power plant sites and starting the initial permitting for the large independent power producers that were desperately trying to expand throughout the United States.
The second area of specialization involved leading teams that we would assemble for our main client to conduct due diligence on fleets of power plants that were being offered for sale by the incumbent electric utilities. These due diligence efforts on the billion-dollar asset sales also included projecting long-term future spot market prices for electricity and then developing pro-forma financials to use to value the purchase. We became one of only a few firms to be recognized by the rating agencies as being qualified to project the spot market prices we used in the pro-forma financial projections.
Unfortunately, this effort, although certainly the most fun and the most challenge I experienced in my career, ran into some head-winds after a few years. The electric power industry, in its eagerness to expand into new, unregulated businesses, had significantly over-built the number of new power plants and, for the first time, experienced a large reduction in spot market prices. These lower prices for electricity killed off both the demand for building new power plants as well as the value and, therefore, the financial incentive to sell off any remaining fleets of existing power plants. We decided to shut our firm down, help our employees find new jobs, and go look for other opportunities.
Racing to Beat Out The Big Boys
After a stint working back at a large power company, my former partners and I identified another market inefficiency: financial transmission rights. The federal and state electric utility regulators had continued to deregulate much of the power industry and encouraged the formation of multiple regional entities to deregulate the long-distance transmission business. These entities, typically called independent system operators, would operate all the transmission assets owned by the regulated utilities in a particular region and make them common carriers, i.e., make them available on equal footing to whatever company wanted to pay for the right to have its power moved from one point to another (eg, from a power plant to a customer’s meter).
In developing this new regulatory paradigm, the independent system operators encouraged the development of auctioned financial transmission rights. In exchange for an up-front purchase price, the winner of an auctioned financial transmission right is awarded all the transmission rents from any company that moves power from point A to point B during the period covered by the auction. Further, these rents are variable in that as usage goes up, so does the amount of the transmission rent so that an appropriate price signal is sent to the market about congestion on the transmission grid. Conversely, little usage results in a collection of a small amount of transmission rents.
We identified that this market was in its infancy and very inefficient. We took about a year to raise a sizeable hedge fund to go and invest in these transmission rights in four different independent system operators. Unfortunately, while there was some early success, the large electric companies eventually moved into the market and, with far greater resources, quickly made it much more efficient. Our long fund-raising effort cost us much of the early profit-making opportunities, and so we eventually folded our hedge fund and returned what capital we had left to our investors.
Reflecting On Lessons Learned
Shortly after we shut down the financial transmission rights fund, I returned to consulting for some long-time clients and eventually retired a few years later. Looking back on my career, I believe there are some lessons that should apply to any industry that is regulated, especially one that is experiencing deregulation pressures:
- Newly formed markets, particularly ones that are created by regulation, almost invariably create market inefficiencies that can be exploited. Regulation, and the effort to deregulate, by definition are inefficient.
- The market inefficiency can occur years before the major industry restructuring actually occurs. The beginning of such a restructuring effort is sufficient to create market inefficiencies.
- There is a tension between the desire to be a small and fast-moving firm to take early advantage of these market inefficiencies, versus joining a large company that has the deep resources to stay in the market for the long-term. There appears to be no one approach that fits all opportunities.
- If you are a small firm moving quickly to jump on a market inefficiency, be alert as to when your early-mover advantage is ending and develop an exit strategy, even if that exit strategy is to simply close your firm.
- Just because you have selected a corporate career, don’t be surprised if you find entrepreneurial opportunities. A strong knowledge of your industry, the regulatory structure, and the deregulation pressures provides you with a competitive advantage. You don’t need training in entrepreneurship if you know the industry well; all other tasks involved in starting a business can be learned on the fly or simply purchased from vendors.
- Do not hesitate to jump into these entrepreneurial opportunities even if you have not prepared yourself career-wise to do so. The rewards, both financial and future career prospects, are well worth the risk.
- A way to minimize some of the risk is to have your company offer strategic consulting services to clients which will pay the monthly bills while part of the firm focuses on investing in efforts to capitalize on the market inefficiencies.
- Pursuing these entrepreneurial opportunities with partners has its plusses and minuses, but I’ll save that discussion for another day.
Enjoying Semi-Retirement
After almost 25 years in the Midwest (Chicago and Ann Arbor), my wife Mary and I have moved to St. Augustine, Florida, the nation’s oldest city. We live on a barrier island that protects the city’s harbor. I am mostly retired, occasionally helping out a long-time client with the development of new large-scale solar projects. I also teach a class at Flagler College about all aspects of energy called Energy Markets, Economics, and Policies. Our two daughters are now both out of graduate school and settled into their careers, one in D.C. and the other in Northern California, and we are traveling to see them as well as taking an occasional trip overseas.
