June 1 , 2002
Plants for Sale: Pricing the New Wave
- long-dated offtake contracts, not in the steel." 4 Goldman brings capabilities that are currently short in the power market, including a strong balance sheet, credit risk analysis skills, and an energy-trading platform. These offer the firm an important advantage in making good acquisitions and then leveraging their value.
- Taking a smaller but noticeable bite were LSEs, which purchased around 10 percent of the capacity in 11 deals for more than $1 billion. Thomas Chewning, Dominion's CFO, recently pointed out the motivations for this trend: "While wholesale electricity prices are depressed, the regulated retail prices that Dominion's competitive operation seeks to beat haven't come down. Dominion is skipping the middle man by selling its power to its own customers rather than to other competitive suppliers and utilities. 5 (italics added).
This acquisition strategy faces an important hurdle. In mid-December, FERC ordered a hearing to review OGE's announced purchase of the McClain power plant. OGE plans to fold the plant into its rate base. FERC is concerned the transaction may give OGE too much market power.
The last two years have been overwhelmingly bad for many power plant owners and their financial backers. Reserve margins and power prices seem unlikely to improve in the near term for most regions, or even in the medium term for many regions. These are entirely different circumstances from those at the start of the earlier generation asset-sale wave (1997-2001), when the promise of deregulation initiated the sector's boom-bust cycle.
What do the present market conditions mean for future asset-sale activity? Six factors are driving an accelerated pace of asset sales and increasingly downward pressure on the prices of capacity:
- More than 60 GW of capacity on the block includes a number of large portfolios-AEP Texas generation, El Paso, TXU, and Entergy;
- Developers and financiers of capacity coming on line are likely to exit their investment (e.g., Exelon's turnover of its Boston Generating Co. assets to BNP Paribas);
- Power purchase contracts, many above market, will be rolling off in the near term, creating a buyer's market for power and a capacity-owner's nightmare; 6
- The writedown of assets to market value, as required by accounting rules, will help narrow the bid-ask spread;
- Financial-distress fatigue will take its toll. The financial wherewithal and patience of many distressed owners and new owner banks are likely to wear thin; and
- Old and inefficient capacity in the rate base is not likely to be retired any time soon. Indeed, this capacity is likely to grow as a result of transfers into the rate base of capacity owned by unregulated affiliates, as well as newly acquired or built plants. 7
Strategically, buyers going forward likely will continue making acquisition decisions based on the credit quality of the existing off-take contracts, or on their ability to sign contracts with credible counterparties. Such a strategy is largely a response to the present business environment-characterized by illiquid wholesale power markets, regulatory uncertainty, a heightened sense of credit risk, and the financially weak state of many energy companies. This environment favors investment banks with capabilities to measure,