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expected, prices for the recent merchant deals are considerably lower than what previously was witnessed in the market. Although always difficult to compare due to differences in asset-specific characteristics, prices on these merchant transactions are closer to the $100/kW to $300/kW range.
But how long will these new financial players remain in the industry? While the ultimate impacts are still unknown, the market power screen will likely impact both the number of asset sales to financial players and the amount of time they hold the assets. Given the number of assets for sale in the industry, and the potential that banks currently holding assets will soon tire of those positions, more assets are likely to be sold to those willing and able to put capital to work in the current market. With traditional merchant buyers limited by credit and balance-sheet problems and the new market power screens hamstringing regulated utilities, financial players will continue to build ownership share.
How long they retain ownership of the assets, however, will depend on a number of factors, including how quickly the next wave of buyers materializes. That is a function of how quickly the merchants rebound, whether or not outside interests enter the market, and to what degree the new FERC market power screens actually affect regulated utility purchases in the future. But no matter how much of a foothold the financial players gain or how long it takes to sell, ultimately the assets will return to their natural owners (companies with ownership characteristics that match the underlying investment).
Generation Assets: Likely to Follow a Circuitous Route
The electric power industry is characterized by a number of factors that tend to delimit the universe of entities that can be successful in the market in the long term. Electricity production is cyclical, highly capital intensive, commodity-based, and volatile. Cyclical, capital-intensive industries are characterized by relatively low long-term returns. And while the current industry downturn is likely more severe than future down cycles (due to the exceptionally high degree of current overbuilding), the ability to survive and profit through these cycles requires certain key strengths.
These strengths include low cost of capital, portfolio size, and a large capital base that can provide scale and accommodate the sometimes large capital and major maintenance expenditures required by the industry. In addition, generating plants are complicated facilities to operate, and the markets in which they run require skills and infrastructure. Expertise in risk management and trading, contract management, market modeling, the environment, technology, and regulation can provide a competitive edge in a market defined by long-lived generating assets.
Finally, all investors acclimate easily to constant high returns. It's the downturns that tend to separate them. The market for generation is cyclical, and the cycles can be deep and long. Lack of a long-term (10-plus years) investment view will keep many players out of the market, unless specific opportunities arise on a very opportune and short-term basis.
Clearly, the inherent nature and characteristics of generating assets speak to the type of investor that is likely to be successful over the long