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The Merchant Asset Fire Sale: Deal of the 21st Century?

Companies that were on a buying spree before 2001 are putting assets worth billions n the block
Fortnightly Magazine - March 15 2003

market, making merchant plants more saleable. For example, energy clearinghouses could facilitate growth in trading. Likewise, increased activity by large trading houses and financial institutions would bring greater liquidity into the market. And progress to implement the Federal Energy Regulatory Commission's (FERC's) standard market design (SMD) could bring greater volume as well.

Third, companies might find alternative ways of raising cash. For example, master limited partnership (MLP) vehicles have been used by petroleum companies to securitize and manage diverse oil and gas assets, and this structure holds potential for merchant power assets as well.

These and other trends seem poised to break the logjam that has been holding back a veritable flood of assets in the secondary market. If and when the logjam breaks, the industry could embark on an asset reshuffling that will change the industry for good.

Merchant Malaise

In some ways, the utility industry seems to be regressing to an earlier stage of its development.

The most dramatic example is found in the wholesale electricity markets. Robust markets- which in part spurred development of more than 90 percent of U.S. capacity additions since 1997-have shriveled to less than one-third of the volume they traded before Enron's December 2001 collapse.

With no fluid marketplace to sell into, merchant generators are forced to retreat back to an earlier independent power producer (IPP) type of business model.

"People want to go back to something more traditional, with predictable, longer-term cash flow," says John Boken, a senior director with Kroll, Zolfo, Cooper, which is the restructuring arm of risk consultants, Kroll Inc.

Thus, merchant generators are now hunting for longer-term contracts, and some are finding them. Atlanta-based Mirant, for example, recently signed contracts to sell 325 MW of capacity through 2008 to Nevada Power Co. The contracts offload power from Mirant's new 533-MW plant at Apex Industrial Park near Las Vegas.

Other generators have signed similar contracts recently, and more might be coming as utilities seek price stability in an unpredictable wholesale market. But regulatory treatment of such contracts will determine how prevalent they become.

"Utilities want to offer tolling agreements and long-term power contracts, but they won't do it unless they can pass the costs to ratepayers," Bodington says. "Ratepayers will pay for volatile markets one way or another. The smart way to do this is for utilities to manage the volatility in markets on a portfolio basis, with the prior approval of regulatory commissions."

This trend might even evolve into the return of competitive bidding, as with the utility solicitations that spurred IPP growth in the early 1990s. Some utilities-including Xcel Energy and Duke Power-already have issued significant requests for proposals, and more might follow as utilities review their power-supply portfolios.

"Competitive bidding would be a more economic use of merchant power assets than gratuitously letting them get stranded in a Darwinian survival-of-the-fittest exercise," Zimmer says.

At the same time, merchant plants also could benefit from implementation of FERC's SMD. Significant complications impede the progress of the SMD nationwide-including challenges in the U.S. Congress-so market risks will persist in the near