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Power Plant Sales: Valuing Optionality

Market risks and volatilities are driving asset values higher.

Fortnightly Magazine - May 2006

About 10 percent of the power-generating capacity in the United States has changed hands in the past three years.

Ownership has shifted among utilities and independent power companies, and investment funds have flocked to capitalize on energy-market volatilities. How these ownership changes will shape the U.S. power industry in the long term depends on numerous factors, many of them difficult to predict.

“A new market structure is emerging, and it presents more uncertainty than many companies are accustomed to managing,” says Michael Valocchi, a senior managing director with FTI Consulting in Philadelphia. “As a result, in the next phase of asset sales, we will see a greater emphasis on optionality—not just financial value, but also operational and strategic importance.”

How buyers factor the variables and predict the future will distinguish winners from losers in the evolving power-generation industry.

Shakeout Coming

The recent wave of power-plant sales peaked in 2004, with about 47 GW reported that year, according to a database of public records compiled by Bodington & Co., a financial advisory and consulting firm in San Francisco. That wave continued at a somewhat diminished level through 2005, with some 30 GW of net capacity sales publicly reported (see Table, “U.S. Power Plants Sold, 2005”) .

The total number of deals diminished significantly year-to-year (33 deals in 2005, versus 46 deals in 2004), and almost half (48 percent) of the total megawatts changing hands were contained in one deal—the 14.5-GW Texas Genco acquisition by NRG Energy. NRG paid $7.1 billion to acquire interests in 13 facilities from the private-equity consortium that acquired Texas Genco in 2004.

“A slew of deals have begun to work their way out of restructuring, and have been recapitalized with interim ownership,” says Eric Silverman, a partner with Milbank, Tweed, Hadley & McCloy in New York. “Over time, these assets are expected to be consolidated regionally by existing strategic players”—namely, utilities and independent generating companies.

In 2005, load-serving utilities acquired 5.4 GW of competitive wholesale generators, and independent power companies bought 8.5 GW of capacity from other IPPs and financial investors, in addition to NRG’s big gulp (see Figures 3 and 4, “Value by Buyer Type” and “Value by Seller Type”).

“We’ll see a lot of these assets move into the control of ratepayer-at-risk entities—IOUs, municipals, and cooperatives,” says Jeffrey Bodington, principal at Bodington & Co. “Private-equity firms expect to own the assets until there is more capacity demand and the regulatory waters clear a bit. Until then, assets get healthier before they are sold off.”

Specifically, bankruptcies, write-downs and ownership changes allow facility owners to adapt their financial structures to changed market conditions. “The dark side of project financing is that everything gets screwed down so tight, when market assumptions change, the deal isn’t flexible enough to change with them,” Bodington says.

Accordingly, the recent wave of plant divestitures has diminished since 2004, as auctions have cleared the backlog of distressed assets. Nevertheless, more plants are

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