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What's a Power Plant Worth

Fortnightly Magazine - September 15 1997

addressed in evaluating and valuing power plants, including:

• Fuel Position. What fuels are used? How are they purchased? At what price? What commitments will convey to the new owner? When do contracts expire?

• Supply Options. Can new, less-expensive or less-risky suppliers be obtained?

• Competitive Position. A plant may lose its position in the market if competitors improve.

Overall, investors should expect changes in linkage between power prices and fuel-market dynamics. In fact, merchant plant buyers largely will be flying blind over the next few years, as we don't yet have much of the experience or information needed to develop a coherent view of the market (em and won't until the merchant plant market has existed for some time.

Deciding When to Sell

Power plant owners will sell their generating assets when cash is more valuable than continued ownership, although they may also seek other benefits. %n5%n Plant owners may want to sell for one or more of three basic reasons:

• Mandated Divestiture. Massachusetts and California utilities, for example, are auctioning their power plants in response to state-mandated deregulation.

• Mitigation of Loss. Its operation may be uneconomic or inadequate due to expected market conditions or a deficiency.

• A New Business Strategy. Some companies may decide to get out of generation. The cash may be more valuable elsewhere.

Plants may also be sold with the provision made for continued later use of the output but not as owner. For example, Commonwealth Edison sold its 490 MW State Line plant to Southern Electric International and its 1,108 MW Kincaid plant to Dominion Energy. ComEd will supply the fuel and will take all of the electric output from both plants for 15 years.

The tendency of most plant owners (who want to stay in the business) will be to try to sell their least-attractive power plants. The problem with this strategy, of course, is that they are likely also to be the least attractive to a buyer.

Deciding When to Buy

Power plant valuation for evaluating plant acquisition decisions in a competitive market requires five sequential activities:

1. Weigh the Spark Spread. Determine the outlook for a positive spark spread for the specific plant. Both electric and fuel market issues must be considered. Fuel issues include plant, competition and market factors. Electric issues include trends and cycles in the markets of interest.

2. Study the Candidate. Assess plant-specific characteristics. Estimate the expected contributions to set cash flow under a variety of potential market circumstances.

3. Deflect Risk. Determine how well market risks can be managed using the various techniques available to manage them.

4. Balance the Portfolio. Assess the correlation of the proposed investment with other portfolio assets and perform a thorough sensitivity analysis using different assumptions. Diversification is a key issue. Few integrated utilities today are well diversified. %n6%n

5. Test the Price. Determine whether the market will support the price at which the power plant will be bought or sold. Most often, there is not yet sufficient information to make this assessment.

Keeping Spark Spread Positive

Once a power plant changes hands, the owner's