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Post-Meltdown Valuation

Credit-quality concerns join fuel and market factors to affect power-plant valuation

Fortnightly Magazine - January 2008

eventually will calm the markets and propel investors forward in search of profits, value creation, and competitive advantage.

Regional Plays

The United States is a good place to invest in an uncertain world. It’s the largest economy in the world, and still growing at a respectable pace. Despite relatively steady load growth, fuel demand for power generation largely is consuming the reduction in industrial load as energy-intensive industries move offshore looking for lower costs — not just for energy, but also for labor and materials. As a result, the average energy intensity of U.S. households has been increasing, although it’s already one of the highest among developed countries. Since the 1970s, the average home in the United States has doubled in size. As old inefficient appliances vanished, energy usage did not decrease but increased with the new electronic gadgets, such as plasma TVs and other electrical devices. The United States needs vast amounts of infrastructure investment, particularly in transmission and generation businesses.

The key problem for the U.S. energy market is uncertainty about how to meet its growing energy needs. The last merchant-boom market was dominated by gas-fired, combined-cycle power generation assets. Now there are concerns about fuel diversity as well as reductions in greenhouse gas (GHG) emissions. The long lead times, added technology and regulatory risk and the expected cost of new climate-friendly power plants — most notably nuclear and coal-gasification facilities with carbon sequestering — make it extremely critical for the energy industry and investors to understand how deep and how long any credit crisis is going to last.

As we enter the next build cycle, debt markets will play a crucial role in facilitating the new energy projects. Stricter financing terms, lower leverage and higher debt rates are all possible outcomes of the crisis. These factors very likely will delay financing of several new projects, as well as merger and acquisition deals, while others will proceed with higher debt costs. Senior executives likely will put deals on hold for a few months to see if the markets stabilize and show signs of recovery. If the problem persists longer, this could substantially alter the financial structure and timing of many deals in the pipeline today. Significant delays in particularly resource tight regions would lay the groundwork for the next boom cycle.

Global Energy’s Power Generation BlueBook asset advisor analysis found the average North America asset value has increased by 6 percent to $773/kW. 1 Value has moved significantly in some regions, and for some fuel and asset types.

• ERCOT stands out from the rest with low reserve margins. Several mothballings and retirements, along with higher than expected demand growth over the last few years, have caused reserve margins to drop to critical levels. Despite the lack of any support from a structured capacity market, projections show robust cash flows for coming years in this market. In addition to projects now under construction and some restarting mothballed stations, this market needs new capacity as early as 2008.

But although combined-cycle plants might expect significant energy revenues, they are still not