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Business & Money

The consequences of exuberance are all around us.
Fortnightly Magazine - January 2004

a power purchase agreement (PPA), but such plants are worth only the discounted value of their contractual revenue streams; the iron can usually be had for free.

In announcing the $2.4 billion acquisition of the 3,300 MW Congentrix fleet, a Goldman Sachs executive stated, "The value is in the long-dated offtake contracts, not in the steel." 1

This seems a little disingenuous. There certainly is value in owning a fleet of state-of-the-art generating facilities, and Goldman was shrewd to capture the bucketful of real options embedded in the Cogentrix assets.

Drivers of Generation and Transmission Values

Figure 1 on the previous page provides a high-level forecast from Energy Security Analysis Inc. of capacity values in selected markets. Note that this chart presents several dramatically different capacity situations and consequently valuation challenges:

  • The chronically oversupplied. This includes Entergy, Texas, and Nepool. In these areas, capacity is so abundant that for all practical purposes merchant generation has no value. Given the effects of discount rates, by the time the plant comes "into the money" in the capacity market it has little or no present value. QFs have some value, but there is a lot of regulatory risk in this arena, and monetizing much, if any, of this value may be difficult. Plants with long-term PPAs have whatever value the spreads in those agreements generate.
  • The balanced and the under-supplied. New York, California, parts of the Midwest. In these areas, we make distinctions between three types of capacity outlooks:
    • Existing generation facilities with PPAs and QFs have whatever the values of those contracts are, plus some modest additional value for the steel in the ground, minus a discount to account for regulatory risk (for example, changes in utility obligations to buy power from QFs).
    • Merchant facilities without PPAs and QFs have very modest values because of the general investor aversion to owning power plants.
    • Facilities that need to be built to accommodate a specific need are the nirvana of generation development. A few projects-the SCS Astoria project in New York City is one-have secured capacity PPAs and therefore are financially secure. This is probably how the next 5,000 MW of California capacity will have to be developed.

Beyond these typologies, buyers should appraise plants in terms of their location and in terms of how future transmission expansions affect the deliverability in their area. For example, currently low/no-value facilities in Southeast Massachusetts and Rhode Island would gain value, while theoretically high-value urban capacity might lose value if major transmission projects currently under development are completed.

New England as a whole has no foreseeable need for new capacity, but southwest Connecticut needs a solution for its congestion issues. FERC had ordered the New England ISO (ISO-NE) to develop a locational capacity market (pioneered by the NY-ISO), by which the promise of higher capacity payments in the load pocket would motivate investment in either local generation or merchant transmission. That device might work one day, when investors regain faith in power-market regulation.

Meanwhile, in the absence of merchant investment, the burden falls on the ISO and the incumbent