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Gas Turbinemania: The Merchant Power Plant

Why it happened? Who lost in the bust? Who will survive to build another turbine?
Fortnightly Magazine - June 15 2002

high priced [based on the forward price curve] because the marginal producer would be inefficiently burning expensive oil or natural gas, in an old steam boiler. Tired coal units would fade away, chased off by the EPA.

The optimism was palatable. Calpine, AES, NRG, Mirant, and Dynegy stocks surged to near dot-com multiples on the idea that they would be building power plants for many years to meet America's insatiable demand for power as a result of what many believed would be an endless economic boom ().

Furthermore, financing for gas turbine construction was readily available. In fact, banks were lining up to finance projects.

And the merchant generation bubble grew until Enron's collapse essentially pricked it. But the underlying flaws in many of the assumptions that were made of the prospects for the U.S. merchant markets and their longevity were evident two years earlier.

The Early Birds Got The Worm

Joseph A. Schumpeter, the mid-20th century theorist of entrepreneurship and technological change, said that profits accrue to the early birds and are competed down by later entrants.

The pioneers in the merchant plant turbine business confirm Schumpeter. They cut their teeth in an entirely different market: the qualifying facility (QF) market of 1978 to 1992. In that market, they learned about project development, financing, and management of gas turbines (and coal plants), but with constrained risks.

Most QF projects were financed based on utility take or pay contracts that regulated utilities reluctantly awarded as required by federal law-the Public Utility Regulatory Policies Act (PURPA) of 1978 (). Their earlier projects, while they were developed based on utility purchase agreements, were not without risk, as AES demonstrated when its first two projects (at Deepwater in Texas and Beaver Valley in Pennsylvania) failed because they could not recover rising fuel costs at the agreed to power sales price.

This experience may explain AES's early avoidance of the market price risk in the new U.S. merchant environment. In the United States, AES became a toller, 2 letting its partner-Williams Energy-take the spark spread risk.

AES's 2001/2002 stock crash followed Enron's, but was driven, in part, by its international exposure, particularly in Latin America. In February, AES decided to exit the competitive electricity supply business. Two other U.S. pioneers, PG&E and Edison International, were also hit hard by poorly performing international projects. Needless to say, in 2001, PG&E, largely due to the California price squeeze it was caught in, declared bankruptcy.

Furthermore, early birds such as Cogentrix, Sithe, LS Power, and Tenaska did well by sticking to U.S. projects and not going public.

In 2001, LS Power sold its plants (5,633 MW) to another ambitious but late arriving merchant-NRG.

One of the few exceptions to the "early bird" trend of eventually selling off its plants or halting its merchant development program was Calpine, 3 which became the most ambitious publicly traded merchant company.

Notwithstanding, Calpine, too, was forced to modify its ambitions in response to the supply glut, and due to the high cost of development capital as a result of debt ratings downgrades by