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.
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 coming to auction all the time, and competition for those assets remains high.
“A huge amount of equity has been raised that seems to be targeting energy and power opportunities,” Silverman says. “We likely will see more assets changing hands because of this new liquidity in the sector.”
Prices for power plants might be reflecting this trend as well. In 2005 the average price paid per kilowatt increased significantly from 2004 (see Figure 5, “Prices Rebounding”). This increase is attributable to several factors, not the least of which is the large number of buyers in the market.
For example, Goldman Sachs recently auctioned an equity stake in the East Coast Power facility adjacent to Newark airport in New Jersey, netting a price that valued the facility at $1.3 billion—nearly twice the price tag the investment bank had put on the plant less than 18 months earlier.
“There is a lot of money in the marketplace, and it is chasing too few assets,” Valocchi says.
In addition to buyer interest, factors putting upward pressure on prices include narrowing supply margins in some regions, as well as fuel and environmental considerations.
“Every time you turn around, there is something changing in the utility market,” Valocchi says. “We’ve had the highest amount of volatility in the fuel market that we’ve seen in decades. The generating fleet is aging, and demand trends are not well understood. And we don’t have a good handle on demand trends at the granularity we need to plan for the next 5 or 10 years.”
These and other factors add up to an increasingly uncertain environment for power generators and load-serving companies, and make certain assets more strategically valuable—because of geographic, fuel or environmental characteristics (see Figures 1 and 2, “Value by Region,” and “Value by Fuel”).
“People are looking very carefully at fuel-cost management and volatility-related issues,” Bodington says. “It is devaluing gas plants and adding value to alternatives.”
This effect might not persist indefinitely, however. The current emphasis on fuel diversity has tipped the scales away from natural-gas fired assets, but over time their value may be buoyed by operating flexibility, environmental performance and efficiency potential.
“If you talk to people who are planning new generation, the only thing they want to talk about is coal,” Silverman says. “People are still reeling from the run-up in gas prices after last year’s hurricanes. But many analysts believe gas prices will fall, and asset buyers need to look critically at the implications of that, as well as ... everything else.”
Current trends in U.S. power markets suggest supply margins will continue shrinking as power demands increase, and facility assets generally will maintain strong valuations. But how these market conditions will affect financial performance varies among individual assets. What role a given facility plays in its regional market—including its ability to dispatch as expected—will depend on a host of variables.
“Most of these combined-cycle plants were built for baseload operation,” Silverman says. “A key question is whether they are likely ever to operate that way. Most have been at 50 percent capacity factor or less since 2002 or 2003. Will existing combined-cycle plants run as intermediate generators, or will coal plants knock them out completely?”
The answer affects not only the value of assets in the secondary market, but also the business case for new power projects. “Power companies are grappling with this issue,” Silverman says. “The value of an asset depends on your vision of the future.”