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Going to the Bank

Financial buyers are snapping up power plants faster than at any time in history. The asset shift represents an interim step in a wholesale-market transformation.

Fortnightly Magazine - June 2005

In 2004, the market saw all manner of private-equity investors bidding on power assets. Most of these players are focused almost entirely on a basic buy-low, sell-high strategy-acquiring undervalued assets and enhancing their value by combining and restructuring portfolios. With a few exceptions-notably energy-focused limited partners such as Energy Investors Funds-most private equity firms are likely to stick with their buy-low, sell-high strategies. Thus within several years these firms can be expected to sell off the plants they've acquired.

To whom they might sell these assets is anyone's guess, but one logical buyer group includes investor-owned and public utilities. The raw number of megawatts bought by utilities in 2004 was dwarfed by the overall total of plants changing hands. However, when large portfolios acquired by financial investors are taken out of the total, the back-to-rate-base trend stands out more clearly; utilities acquired about 10 percent of the remaining capacity (see Table 2) .

"If you recognize that the big deals included a lot of pretty old plants, and you look at where the new stuff and merchant capacity went, you see erosion in the competitive capacity that remains in the market," says finance consultant and broker Jeff Bodington.

These two trends, taken together, suggest the wholesale power market is going through a major transformation. The industry's final shape won't be clear until private-equity firms sell off their plants, ending their role as an interim repository. Who buys the majority of the assets might depend on regulatory trends, such as the advancement or stagnation of RTOs, competitive dispatch programs, and equitable approaches to paying for reactive power.

"We are in the early phase of testing what capacity payments might look like," McGinnis says. "One hopes that each region will set payments based on the plant's importance to the reliability of the grid."

Such developments might well determine who's still around in five years to buy the assets private-equity firms will be selling. Ultimately, the current direction of the deal flow could reshape the U.S. power industry for decades to come.