[BETA] Fortnightly

USGEN IS THE NATURAL CANDIDATE TO PURCHASE NEES' generation assets. We have a well-established commitment to the region; we have strong power plant operating experience; and we have been a leader in promoting competition and customer choice in gas and electric industries."

(em USGen President and CEO Joseph P. Kearney

In August 1997, U.S. Generating Co., an affiliate of PG&E Corp., successfully bid $1.59 billion in a competitive auction for all of New England Electric System's non-nuclear generating business (18 power plants, plus power purchase contracts and other assets). The transaction marked the first major sale of electric generating assets in preparation for U.S. deregulation; following close behind came the sale of three PG&E plants for $501 million and 10 Southern California Edison plants for $1.12 billion. More will follow, as states encourage utilities to divest their generating assets to prepare for competition.

One detail merits a closer look: USGen's bid price offered a substantial premium over book value, listed by NEES at $1.1 billion. Many observers blamed USGen's apparent high bid price on its over-eagerness to position itself early in a market that is rapidly growing competitive. This explanation appears short-sighted, however. It assumes that PG&E stockholders are indifferent to how the company invests its dollars or whether it receives an adequate return. It fails to explain the value that comes from being the "first mover" in a market.

Instead, assume USGen's bid reflected sound financial analysis (em that it recognized how the assets will contribute to positive cash flows. The challenge then is to grasp how a company like USGen can boost the apparent value of the NEES assets by combining them with its own operations. Commodity-producing assets, in this case, should not be viewed on a stand-alone basis. Instead, identify how the NEES assets, as operated by USGen, will now fit within a strategy for minimizing risk and maximizing value for an entire integrated portfolio of assets.

The Regional Market: Assumptions and Variables

As a regional power market, New England tends to be isolated and high-priced. At approximately 10.2 cents per kilowatt-hour, New England's electric power rates are 44 percent greater than the national retail average. Three reasons stand out for the region's high rates: high capacity costs, a high-cost fuel mix and transmission constraints. However, these transmission constraints likely enhance the value of the NEES production assets.

About a quarter of the region's estimated 27,195 megawatts of capacity comes from nuclear plants; some 3,600 MW of this capacity is more than 20 years old. Many of these plants have either been closed or are undergoing lengthy maintenance, including Connecticut Yankee and Millstone, making supply uncertain.

The region has limited tie capability to adjacent power systems. Major interties include lines to Quebec, New York, and New Brunswick, Canada. These ties are fully subscribed under existing power purchase agreements. Significantly, there is no direct tie to the Pennsylvania-New Jersey-Maryland power pool. This weakness (plus the limited extent of ties through New York) severely constrains imports of low-cost power from the Midwest.

Attracted by deregulation and the region's high capacity costs,