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Watch the Cycle
Can the upward swing in global power infrastructure investment be sustained?
The global power sector is now in year three of a strong cyclical recovery. As infrastructure investment cycles go, in theory at least, the power-sector cycle over the past decade has been short in duration, and volatile. The current recovery is being driven not only by rising demand for power, but also by the huge levels of liquidity in the global financial markets. As asset valuations rise, investors are beginning to question just how long the current up-cycle will last, and at what valuation levels it will top off. And as power utility balance sheets and projects become increasingly leveraged, they might also begin to consider the likely shape of the next inevitable down-cycle.
We examine these questions in the context of an overview of the sector from a global perspective.
A Bit of History
The globalization of the power sector began in the 1980s and accelerated in the 1990s following deregulation initially in North America and Europe, and later in Australia and Asia. Then, as the deregulation and privatization of power sectors elsewhere around the world became the norm, a wave of investment activity was set off primarily by U.S., European, and Asian power companies.
The sharp contraction that began in 2001 resulted from overcapacity, slowing demand, and low electricity prices, together with a sudden growth in short-term debt maturities held by a then highly leveraged industry. The dramatic collapse of the Enron business model catalyzed sector-wide credit downgrades and a tightening of financial covenants. Liquidity dried up and global-power companies scrambled to shed non-core operations and higher-risk merchant plants to avoid bankruptcy.
The Rise of Financial Investors
In the process, financial investors, both by default as creditors (U.S. and European commercial banks took possession of approximately 16,000 MW of generation assets due to defaults) and as opportunistic buyers, became increasingly larger owners of power assets. In fact, financial investors have accounted for nearly two-thirds of capacity acquired in the United States over the past few years. Private equity funds, infrastructure funds, and hedge funds have proliferated and entered the sector in a big way, and financing instruments have evolved to compete in the increasingly liquid environment. Savvy U.S. investment banks have acquired portfolios of power-generation assets and are applying the capabilities of their own energy trading arms to maximize the value of these portfolios. In the rush to lend, investor classes also have moved beyond their traditional product offerings: Commercial lenders are making mezzanine loans, mezzanine lenders are buying equity stakes, private equity funds are managing senior and subordinated debt facilities, and hedge funds are providing all forms of capital to the sector.
Global Investment Snapshot
Global investment activity in the sector has shown considerable growth in recent years. The value of completed power sector mergers and acquisition (M&A) transactions in 2005 was a record $157 billion, with most activity in Europe and the United States, up from approximately $40 billion in 2003.