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Keys for Success in Power Plant Investing

Fortnightly Magazine - January 1 1999

It's not as straightforward as it seems, says an industry veteran.

No one can foresee with a high degree of certainty how electric energy markets will be structured over the long-term. The changes facing the electric energy industry may be as profound as those upheavals we've seen in the airline industry during the past two decades. In the "good old days," a flight from New York to Chicago had one price and an electric generating plant had a regulated price for each kilowatt-hour produced. Today everyone on the New York to Chicago flight pays a different price from his seatmate, and electric production pricing seems to be moving toward such severe volatility that it may make airline ticket pricing appear tame.

Investors face substantial risks in a restructured electric generating business. Some of these risks are rooted in the capital-intensive and commodity-like nature of electric generation assets, and some are driven by regulatory effects likely to linger into the future. However, there may be opportunities for successful investment strategies founded upon deep knowledge of the marketplace and superb operational execution.

There are some fundamental understandings and objectives potential investors can - in fact, must - achieve to develop successful electric production investments. These considerations include:

• specific market knowledge;

• specific transmission system knowledge;

• detailed site characterization;

• available technology options;

• creative partnerships; and

• superb operations.

Thoughtful, fact-based investment decisions with these objectives in mind can go a long way toward enhancing the probability of success as the substantial investments that are part and parcel of electric production assets are made. Substantial risk exists but, once made, a decision to participate in ownership of production assets can be successful.

Specific Market Knowledge. As the independent power producer industry flourished in recent history, the economics of new generation were quite simple. An IPP with keen skills in site development as well as fuel supply and power sales contracting could enjoy a high degree of success because the purchasing utility provided a guaranteed customer for the two products the IPP sold - kilowatts (capacity) and kilowatt-hours (energy). Once these key contractual relationships were in place, the IPP was immunized from market forces because the host utility was required not only to purchase all the output at a defined, guaranteed price but also to provide all other services including reserve capacity, voltage support, spinning reserve, etc.

Going forward, the world will not be so simple. In this new world, knowledge will be king and may be neither easy to acquire nor intuitive.

Most generation plants, whether existing or new, will participate in a regional pool and sell to customers under pool-determined rules. The rules may vary substantially from one region to another but will be a primary determinant of a given facility's revenue stream. Salable products will vary according to the needs and circumstances of each pool. In such a world, pool-specific knowledge will be essential to achieving attractive rates of return on investment.

For example, the New England Power Pool has unbundled generation into seven products; installed capacity, energy and various ancillary services are expected to be