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What Is Your Power Portfolio Really Worth?

Change is the only certainty in today’s market.

Fortnightly Magazine - October 2005

experienced volatility in the past two years, coal prices overall are viewed as being less volatile than gas prices. The timing issue is a simple artifact of calculating net present values; the coal plants often are scheduled to begin operation five or more years in the future, and their merchant value is appropriately looked at as an NPV in the on-line year, removing the under-performing early merchant years and using a lower discounting factor for the balance of the investment period.

As long as current gas prices remain well above the $4/MMBtu level, there will be continued interest in using coal assets rather than gas assets to meet new base-load demand. For many, this will simply be seen as the return to normality. However, there is a downside risk for a coal investment; if the gas prices drop unexpectedly, the value of coal assets can go down significantly. Figure 2 shows how the NPV of a coal unit changes with gas price change at the Henry Hub. While the base case merchant value of coal is in a $750/kW (deterministic) to $820/kW (stochastic) range, the value can drop to a $610/kW to $630/kW range if the gas prices decrease by $1.50. Although a coal investment can be a good hedge against gas price increases it also brings a downside risk  (see Figure 2).

Energy Markets Are Regaining Confidence

After the failure of merchant generation, and several bankruptcies, energy markets finally are regaining the confidence of investors. In the last two years, merchant generators have made considerable progress by paying off debt, refinancing, addressing legacy issues, and divesting non-core or non-performing assets. Other energy companies are rethinking their overall strategy and divesting some non-core businesses they acquired in the 1990s. As independent power producers demonstrate the ability to improve performance in the face of the currently depressed markets, investors are warming up to the U.S. energy market again.

Several energy companies have refinanced their debt with more attractive rates compared with a year ago. KGen Partners recently refinanced its acquisition of Duke Southeast assets at much lower rates, even though it had been only seven months since the first financing. Calpine, NRG, and Astoria Energy LLC are some of the others who took advantage of refinancing opportunities.

However, uncertainty remains in the industry. Many believe the worst is over, and view lower interest rates as another sign of this belief. Others view the lower interest-rate environment as a sign of increased demand for the limited amount of power-sector debt available, and are concerned that the market has become overly optimistic.

Market Players Have Changed

In the past two years, generation power-plant sales have picked up and continue at a healthy pace, with almost 70 announced transactions of more than 50 GW of capacity. This represents just under $16 billion in total value (cash and debt assumed). However, the buyers and sellers are changing.

Financial players, including private equity groups and investment banks, dominate the buy side, purchasing more than 60 percent of the total capacity sold and representing more than 50 percent of