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Business & Money

An evolving market demands a greater focus on power prices and required return on equity.
Fortnightly Magazine - May 1 2003

sales are on the way. Most of these firms are under pressure from lenders to stop construction programs, raise cash, and reduce debt.

These potential sellers must make difficult decisions. In particular, many would like to sell their merchant projects and keep their high-quality, contract-secured projects so that they have stable earnings for the future. However, with merchant projects likely to require book write-downs, selling contract-secured projects may be the only way to raise the necessary cash.

On the buy side, there are a few survivors and many new entrants. FPL Energy is an example of a long-term buyer who remains active. New participants include private equity firms such as Kohlberg, Kravis, Roberts, and Co. now prospecting for facilities at attractive prices. A quandary many of these will face is that, as explained above, the prices for high-quality, contract-secured projects have not declined. Private equity buyers with high return requirements may not be able to purchase such projects, and many of those buyers will be left with no acquisitions or projects that do involve substantial risk.

Another important factor that will shape the future is the development of trading companies. Nearly all of them have failed. BP Shell remains, and several banks are venturing back. These participants in the market for power provide investment-grade power purchase or tolling contracts to power project owners. With such a contract in hand, a power project moves off the merchant line in Figure 3 and down to the contract-secured line. Liquidity and value rise.

Several regulatory forces are also affecting the market. The Federal Energy Regulatory Commission's nascent standard market design initiative will evolve and, to some extent, shape the risks borne by participants in wholesale power markets.

But state-level regulation is also critical. Deregulation and divestiture are proceeding in Texas, are on hold in many other states, and are retreating in still others. Some may encourage utilities to build their own generation again, some may allow utilities to purchase power projects and bring them into rate base, and other regulators may focus on careful oversight of utility contracts and spot power purchases.

Many challenges remain. Values are determined by the market and income approaches; less weight is placed on the cost approach for valuation of electric generation assets. Volume and value in the market for generating assets will be determined by the financial pressures on sellers, the evolution of new entrants, trading companies, and regulation. Project-specific assessments of risk will be of critical importance in the valuation process of electric generation assets.



Business News Bytes

NorthWestern Announces Whopping $900 Million Net Loss

NorthWestern Corp. expects to report a $900 million net loss for 2002, and it will ask the SEC for a 15-day extension to submit its annual report while it continues to evaluate internal accounting and financial controls. The company said it probably would restate results for the first three quarters of 2002. Northwestern also said it is anticipating that approximately $800 million in charges will be taken against its full-year results, up from $700 million in charges the company estimated in February 2003.