Business & Money

After FERC's Market Power Ruling:

Will financiers dominate the market?

The recent approval by the Federal Energy Regulatory Commission (FERC) of its "interim" market power screen and policies on investor-owned utilities (IOU) affiliate transactions is changing the market dynamics for buying and selling generation assets. Yet, while the market test has drawn plenty of comments and complaints, the long-term effects are still uncertain.

One possible consequence will be a decrease in the number of buyers in the market. IOUs that fail the market power test stand to lose their market-based rate authority, a threat that is likely to dampen their ardor to purchase generation assets. And fewer buyers in the market will serve onlyto further stoke the fire that has been accelerating the purchase of generation assets by financial players.

The recent purchase of a dozen or so of Centerpoint Energy's Texas plants by a consortium of private equity funds marks the latest, and certainly the largest, generation asset acquisition by a financial player. The consortium, whose members include Kohlberg Kravis Roberts & Co. (KKR), The Blackstone Group, Hellman & Friedman LLC, and the Texas Pacific Group, paid $3.6 billion for a portfolio of assets with an aggregate net generating capacity of 14,153 MW.

This transaction continues a trend started several years ago following the collapse of the U.S. power markets. Falling generation asset prices and increasing capital requirements in the industry has attracted a considerable amount of interest from financial players that entered the market hoping to buy assets on the cheap. Meanwhile, many traditional players-merchants and utilities-were relegated to the sidelines by heavy debt loads and reduced credit quality.

The shifting ownership paradigm to private equity groups first took shape when it became clear that many banks had overexposed themselves to the industry and were now unwilling-or unable-to meet burgeoning capital requirements. At this point, hedge funds, followed by private equity firms, swept in to fill the void. Others, including investment banks have also been acquiring assets, as witnessed by the deal announced in March by Bear Stearns to purchase a number of plants from American Electric Power (AEP). Also active in the market are private equity/developer combinations and other non-traditional players capable of leveraging their significant financial reserves, such as GE Capital, GMAC, insurance companies, and pension funds.

Initially, almost all of the deals involved above-market contracts associated with the assets. Others were sold to buyers in a unique position to utilize the asset. Prices during this period were relatively high-ranging from $400/kW to over $1,000/kW-reflecting the value of the associated contracts in most cases.

More recently, merchant plant deals have been coming together. In March, a consortium of Sempra and Carlysle Group/Riverstone Holdings an-nounced that it would buy 10 merchant plants totaling nearly 4,000 MW from AEP for $430 million. Duke's announced sale of eight gas-fired merchant plants in May continued the trend that fed into the Texas Genco transaction referenced above. What started out as one-off individual sales had now progressed to entire portfolios of diversified assets (see Figures 1, 2, and 3). As