1001 North 19th Street
AES Corporation is one of the largest independent producers of electrical power in the world, with an ownership stake in 14 power-generating facilities in six U.S. states (California, Connecticut, Pennsylvania, Texas, Hawaii, and Oklahoma) and four foreign countries (the United Kingdom, Pakistan, China, and Argentina). The company supplies more than 3,567 megawatts of electricity worldwide, with most of its production taking place in the United States and Great Britain. New projects slated for completion in the late 1990s, however, were expected to add at least 1,500 megawatts of electricity to the company's total production output; an estimated 85 percent of such new production was slated to occur in emerging overseas markets in Asia, the Near East, and Latin America. In 1995, AES generated, sold, or marketed electricity in more than 25 countries, ranging from Italy to Vietnam and India to Mexico, all with the aim of building on its role as one of the world's chief suppliers of electricity. AES assets totaled more than $2 billion in 1995, and over $5 billion worth of projects were either in construction or the late stages of development.
AES was the invention of Roger W. Sant and Dennis W. Bakke, who had served together in the Federal Energy Administration (FEA) during the Nixon and Ford administrations in the early to mid-1970s. Sant had been a lecturer at the Stanford School of Business; Bakke, a Harvard MBA and career government employee, was his assistant. As part of their work at the FEA, the two had been instrumental in drafting preliminary versions of the Public Utility Regulatory Policies Act (PURPA).
The law was part of the federal government's attempt to deal with America's energy crisis, which, according to prevailing opinion at the time, was caused largely by American dependence on foreign oil. Seeking to reduce this dependence, PURPA mandated that electrical utilities fulfill any need they might have for new power by seeking out qualified cogenerators and independent, small-scale, private-sector power producers. The law further stipulated that the cost of power provided by these facilities be less than a utility's "avoided cost"--that is, the cost incurred by the utility if it generated the power itself.
Prior to PURPA, by contrast, utilities typically secured additional power by building a new power-generating facility, which was usually oil dependent. Otherwise they purchased new power on the open market from yet another oil-dependent utility. PURPA, however, changed that, since it effectively required utilities to fulfill their energy needs by turning instead to cogenerators and other oil-independent power producers.
PURPA was enacted into law in 1978--four years after Sant and Bakke had left the government to found an energy research institute or "think tank" at Carnegie Mellon University. That was also the year in which President Carter declared America's energy crisis to be the "moral equivalent of war," as Americans experienced oil and gas shortages, long lines at the gas pumps, and fear of what the crisis portended for its future. Because of their formative work experience in government at the height of this crisis and their subsequent related work experience in academe, Sant and Bakke were well familiar with the contours of this problem--and familiar as well with the rapidly emerging business opportunities spawned by the new law.
What Sant and Bakke were quick to realize--and, at the time, were virtually alone in recognizing--was that PURPA had the paved the way for a burgeoning market in independent, private-sector power production. In part this was because of the new law's mandate that outside purchases of power be made from cogenerators and independent, small-scale, private-sector power producers. It also stemmed, however, from the fact that PURPA shielded new producers from costly state government regulation and subjected them instead to less onerous federal rules and strictures. In practice, this meant that new producers typically could undercut a utility's "avoided cost."
AES was founded in 1981 as Applied Energy Sources, and it took several years for Sant and Bakke to taste real success. The novelty of their idea and the untested nature of the market in which they sought to do business made it difficult to attract capital financing. Investors were understandably wary and skeptical of the firm's chances for success. One year's worth of effort netted the firm only $1.1 million in venture capital--a inadequate sum on which to build an electric power company. "From 1981 to 1985," reported The Washington Post, "one potential project participant after another--including ARCO, IBM, Bechtel Corp. and other large companies--marched in and then backed out of agreements with tiny AES."
The firm's luck took a turn for the better in 1985, when Sant and Bakke invested all of AES's assets in a single deal: a Beaver Valley, Pennsylvania, coal-burning plant. The deal was closed in September 1985 and the plant commenced production in 1987, marking a turning point for the company, which would never again have to depend upon the success of a single project for its very survival.
By then, in fact, AES had two plants up and running. Its Beaver Valley facility, supplied 125 megawatts of electricity to residents and commercial outfits in the Pittsburgh area, and its Deepwater, Texas, power plant, which, fueled by petroleum coke, went on line in June 1986 and supplied 143 megawatts of electricity to homeowners and businesses in the Houston area. Financial arrangements for Deepwater had been completed on December 30, 1983, and, in addition to AES, involved 12 other companies: ARCO, Bechtel, J.P. Morgan, eight supporting banks, and the General Electric Credit Corporation.
It was an auspicious start for the struggling company, which, over the course of the next 11 years (1984-1994), proceeded to build or acquire ten new power plants. According to an article in a 1993 issue of Financial World (FW) magazine, the average utility, by contrast, might "build one large facility every 10 or 15 years." AES sales, consequently, more than tripled in two years, rising from only $55.4 million in 1988 to $190.2 million in 1990. Sales grew an additional 75 percent the following year, while net company income witnessed similarly spectacular growth, soaring from $1.6 million in 1988 to $42.6 million in 1991.
Buoyed by its success, the company changed its name from Applied Energy Sources to AES and became a publicly traded company on the NASDAQ stock exchange in 1991. Company stock began and closed the year priced at $22.18 a share, with investors earning 66 cents per share. Sant assumed the position of company chairman, while Bakke became the firm's president and CEO. Together, they owned approximately 27 percent of all AES stock.
In these early growth years, AES's primary source of profits and revenue was the domestic U.S. power market. Bakke, for instance, estimated that up until about the mid-1992, 70 percent of the money that AES spent on new business activity was spent in the United States. The remaining 30 percent, he noted, was spent in the United Kingdom.
These investments yielded very good results. A November 1993 report by the investment banking firm of Kidder Peabody, for example, found that from 1988 to 1992 AES revenues grew at an annual compounded rate of 64 percent. Company earnings during that same time period, the report noted, likewise soared at an annual rate of 136 percent. In 1991, AES was recognized by the leading chronicler of American business, Forbes magazine, as one of "America's fastest growing companies," an honor it again earned in 1992 and 1993.
In conjunction with this success, AES staked out a reputation as one of the world's most socially conscious and organizationally innovative companies. Such distinctions were a legacy of Sant and Bakke and a direct consequence of their backgrounds. Bakke, was a devout Christian who readily acknowledged that Christian beliefs formed the basis of his world view. Sant, too, was raised a Christian, specifically a Mormon, and was an ardent environmentalist. Moreover, Bakke and Sant shared a common formative work experience in the federal bureaucracy, which inspired in them a deep and abiding distrust of centralized bureaucracies in either the public or private sector. Nevertheless, their youthful and idealistic desire to work for the government resulted in a strong and life-long commitment to public service.
Such principles and beliefs made AES a rather unique company. Indeed, Bakke and Sant maintained that the firm's primary goal was to build and nurture a firm that embodied their shared values, specifically integrity, fairness, fun, and social responsibility. A company that embodied these values, they felt, would in all likelihood make money. For AES, however, profits were neither an end in and of themselves nor the chief reason for the firm's existence. Rather, according to Bakke and Sant, money was the natural and inevitable byproduct of the firm's shared values. As Bakke told CFO, The Magazine for Senior Financial Executives in 1995: "The most socially responsible thing we can do is to do a really good job of fulfilling our business mission, which is to provide clean, reliable, safe, low-cost electricity around the world."
By conscious design, in fact, AES plants were among the safest and cleanest in the world, with pollution-emissions rates, accident rates, and plant 'availability' time all setting the standard for the electric power industry. Plant 'availability,' referred to the percentage of total potential capacity at which a plant was able to operate; taken as a group, AES power-generating facilities consistently averaged at least 90 percent availability. Moreover, in 1993 FW magazine reported that "the company's number of lost-time accidents is 44 percent below the national average." Regarding its pollution-emissions rates, AES plants were reportedly running an estimated 58 percent below permitted emission levels for sulphur dioxide and nitrogen oxide, averaging nearly one-sixth the rate reported by the majority of American plants.
To further protect the environment, AES committed itself to a tree planting and preservation program, whereby the company agreed to plant or preserve enough trees to offset the carbon dioxide emissions from its power-generating facilities. Study into such a program was initiated in 1987 after growing concern by company executives that such emissions were contributing to global warming and therefore having a deleterious effect on the environment. The program got underway in earnest two years later when AES committed itself to planting more than 52 million trees in Guatemala over roughly a ten-year period. The project cost the company an estimated $2 million, an amount that reportedly nearly equaled AES profits for that year.
Similar company efforts to plant and preserve trees, woodlands, and forests followed, including a $3 million effort undertaken in conjunction with Oxfam America, an international development group, to preserve 3.7 million acres of South American forest. The program was unique in that to save this land from development and exploitation, AES and Oxfam were helping pioneer a private property-rights approach to environmental protection by helping indigenous peoples in South America establish ownership rights to their territorial homelands. It also involved developing land-management programs that would help keep this land in good stead for decades to come.
Other company-sponsored social programs included the funding and construction of a $1.5 million public elementary school in Panama, Oklahoma, the site of one of its power-generating facilities. According to AES Chief Financial Officer Barry Sharp, this was done to give something back to the town, which had given AES generous tax breaks to build the facility. In 1994, when construction of the school was completed, it was dedicated and turned over to the local school district. AES also established a consulting arm, AES Greenhouse Offset Group, to help other electric power companies be environmentally responsible and progressive. In recognition of these efforts, Harvard University honored AES in 1994 with its George S. Dively Award for Corporate Public Initiative.
Organizationally, AES established a decentralized corporate culture that gave company employees responsibility for most all aspects of business management. "Frequent and intensive cross-training, role rotation, and finance education for everyone are the rule," reported CFO. At AES, no more than three layers of management separated an AES entry-level employee from the firm's plant supervisor, each power-generating facility was responsible for its own affairs, and there were no company-wide departments for finance, human resources, operations, purchasing, or public relations. Consequently, the few company officers assigned to these areas acted typically as distant in-house advisors to the plant project management team responsible for a given project rather than as more conventional hands-on corporate facilitators. For plant financing, for example, CFO Barry Sharp raised less than ten percent of the estimated $3.5 billion needed for AES's first ten power plants; most of the necessary financing was raised by each plant's own multidisciplinary project team, composed of a broad cross-section of AES employees. By all accounts, this management system worked spectacularly well for AES. By giving workers a greater sense of involvement in, and responsibility for, their own professional destiny, employee morale was boosted. In 1995, annual employee turnover was averaging less than one percent, according company executives.
Like all management systems, however, the AES program faced challenges. One of the earliest and most significant breakdowns occurred in 1992 when the company disclosed that employees at its plant in Oklahoma had falsified the results of waste-water test samples in order to retain pollution permits from the Environmental Protection Agency (EPA). The workers responsible for the infraction said they feared losing their jobs if their violation of EPA pollution standards became known. In fact, the infraction actually had little substantive impact on AES since the pollution effect being covered up proved negligible and since the company itself disclosed to the government that it had broken the law. The workers responsible were fined, demoted, and placed on probation, but not fired. Sant and Bakke voluntarily cut their bonus pay for that year by 65 percent and 85 percent, respectively. The company publicly apologized for the incident and paid a $125,000 EPA fine. And employees at the Oklahoma plant imposed upon themselves an additional layer of management supervision and environmental monitoring before eventually readopting AES's standard management system.
Also in 1992 the state of Florida charged AES with misleading state officials about the environmental impact of a coal-fired power plant then under construction in Jacksonville. A subsequent state investigation cleared AES of any wrongdoing. By the time the state eventually concluded its investigation, however, the banks providing financing for the facility had cut off funding for the power plant, thus forcing AES to sell off its financial interest in the facility, cut its losses, and abandon the project, despite the fact that construction was nearly complete.
In spite of these difficulties, AES appeared to have a bright and promising future. In the early 1990s, independent, small-scale, private-sector power producers generated only nine percent of electricity in the United States. The U.S. Department of Energy estimated, however, that they would account for nearly 40 percent of all new electrical generating capacity added in the United States by the turn of the century. Certainly, AES's growth record bore this out, as company profits grew by some 650 percent from 1990 to 1994 and earnings per share during that same time period also grew dramatically, by approximately 500 percent.
Despite the opportunities for continued growth in the U.S. power market, however, AES began to look abroad for most of its new business ventures in the early 1990s. In fact, by 1995, the firm was spending an estimated 85 percent of its venture capital abroad. Six AES divisions worldwide emerged: AES Electric, which serviced Europe, the Middle East, and Africa; AES Enterprise, AES Chigen, which serviced China; AES Transpower (Asia, Hawaii, and the American West Coast); AES Shady Point; and AES Americas (Latin America).
The company's shift to the developing world was in part a natural reaction to its experience with its defunct Jacksonville power plant. The plant's failure underscored the relative difficulty independent power producers had doing business in the United States as opposed to overseas, where environmental restrictions were more flexible in part because the cost of pollution there was more easily offset by the benefits of electrical power. As AES company executive Sheryl Sturges told The Washington Post in 1995: "In the developing world, electricity produced from coal and other sources can make the difference between life and death. It can mean refrigeration for medicines and light for schoolchildren to study by."
AES's U.S. government tax levy rose sharply in the mid-1990s, from an effective rate of taxation of 23 percent in 1993 to 40 percent in 1996. In the developing world, by contrast, which was hungry for electrical energy, governments were eliminating tax and regulatory barriers that stymied the efforts of independent power producers.
In fact, the developing world's heightened need for electrical power was the chief reason AES shifted most of its new business ventures abroad. Electricity consumption in the United States, for instance, was expected to grow at an average annual rate of 1.9 percent until the year 2010, according to the Edison Electric Institute. The demand for electricity in the rest of the world, however, was projected to grow at nearly twice that rate, at an estimated annual rate of four percent during that same time period, according to the International Energy Agency.
According to Sant, the world needed $30 billion worth of new power plants a year through the year 2000. China and India alone, he suggested, would need three times more generating power over the next ten years than all of North America combined, and thus would require some $500 billion in power plant financing. It was expected therefore that, well into the next century, as the demand for electricity continues to grow, AES would remain one of the world's foremost producers of electrical power.