Financial players and load-serving utilities are looking for power asset deals.
Despite talk of wide bid-ask spreads in the past two tumultuous years, some 60 sales of generation assets have been announced. These sales cover more than 22 GW of capacity, valued on a cash-and-debt basis at approximately $11 billion. A wide variety of buyers and sellers have participated in the sales activity, with a pronounced entry by financial players (investment banks and private equity firms) and load-serving entities (LSEs) looking for capacity to serve their load. All plant types-gas-fired, combined-cycle gas turbines (CCGT), simple-cycle gas turbines (SC), cogeneration (cogen), coal, nuclear, hydro, and wind-have been bought and sold.1
The systemic capacity overbuild across North America has not led to the expected fire sales. Indeed, the average $/kW values for capacity in many cases are below new build costs, but not substantially. Two explanations stand out: Many of the plants sold have attractive power-supply contracts, and a large number of the merchant plants with little or no equity value are either not finding buyers or are being withheld from the market until prices recover. Hence, we are likely seeing the early stage of an asset-sales wave. In fact, recent sales reflect an uptick in activity.
Future transaction activity is likely to accelerate. The key drivers for asset sales remain robust: About 60 GW of capacity on the block, power prices in many regions that are unlikely to recover until 2010, and increased financial pressures on a number of merchant and diversified energy companies. Moreover, the ranks of potential buyers are growing as credit-risk-shy utilities show a preference for asset ownership over power purchase contracts, and financial players step into the vacuum.
Generation asset sales during the past two years have covered every type of power plant. As indicated in Figure 1, CCGT assets have been the predominant leader with seven separate transactions representing more than a third of total megawatt capacity sold and total dollar value.2 The average dollar value for CCGT capacity is $495/kW. This high value is related to the profile of asset buyers, which are generally either LSEs or have long-term purchase agreements with creditworthy power purchasers.
Five separate nuclear plant transactions have occurred during this time, two representing British Energy's exit from the North American market after experiencing severe distress in its home market in the United Kingdom. Though difficult to precisely value given complex terms and conditions (e.g., transfer of decommissioning funds), the average value of nuclear capacity is $485/kW. Picking up an efficient plant (95 percent capacity factor), with attractive power purchase contracts and room for synergies with a neighboring plant, Constellation Power's purchase of RG&E's Ginna station for around $800/kW helped to bring up the average (see Figure 1 on p. 48).
Cogen plants account for the greatest number of the transactions and have gained favor because of strong contract positions and favorable regulatory status under the Public Utility Regulatory Policies Act (PURPA). While accounting for more than 15 percent of total capacity sold, cogen plants accounted for almost 30 percent of the total dollar value. By far, financial players have been the most significant buyers of this type of plant-accounting for more than 70 percent of the transactions. Cogen capacity has been the third most highly valued form of capacity after wind and hydro, at around $750/kW.
Coal transactions made up around 15 percent of the total capacity sold and less than 10 percent of the dollar value of the transactions. While in the prior wave of generation asset sales, coal values peaked in the $700/kW range, the average value of transactions thus far is $415/kW. Buyers of coal plants have been primarily large diversified energy companies such as Sempra and Dominion, buying plants in markets adjacent to their regulated franchises.
Simple-cycle gas turbine plant sales comprised a small volume of total capacity sold and dollar sales value. The average value for capacity was $360/kW. The relatively high average value may be explained in part by the buyers' motivations and resource needs. Two-thirds of the buyers were LSEs, with the majority of these either co-ops or municipal utilities.
Transactions involving wind capacity have been on the rise, edging out hydro, the other main renewable power source. The lack of available public information on wind transactions has made it difficult to put a dollar value on the cumulative value of deals. Of those made public, transactions have ranged between $600/kW to $1500/kW. Three hydro deals came in at an average $880/kW, the second highest value for capacity. Such value is largely consistent with the supply-constrained nature of this resource.
Where Are the Transactions Occurring?
The Northeast Power Coordinating Council (NPCC) is by far the region with the most asset sales activity over the past two years. As shown in Figure 2 on p . 49, the region's 11 transactions accounted for about 50 percent of the total megawatt capacity sold and 45 percent of the proceeds raised. The region's higher average capacity value-$700/kW-is attributable largely to high-priced nuclear deals, hydro, and a few rich cogen plants.
In terms of capacity sold, the Mid-Atlantic Coordinating Council (MAAC) and Western Electricity Coordinating Council (WECC) follow with around 15 percent and 10 percent, respectively. The WECC values are somewhat understated given that almost all wind capacity sold in the last two years occurred in this region, and these values are not included. The average capacity sales values are $515/kW in MACC and $640/kW in WECC. The higher values may be explained by active participation in both regions by financial players (targeting cogen capacity) and LSEs.
The NPCC, MACC, and WECC (especially California), with high electricity prices, were at the center of early efforts to deregulate and restructure. Driving the first wave of asset sales was the promise of stranded asset recovery with divestiture. In September 1997, New England Electric System (NEES) kicked off the trend with the auction of 4,000 MW. PG&E's $1.6 billion purchase of NEES's capacity, at just over $400/kW for a technology and fuel-diversified portfolio, drew both applause as a gutsy first-mover strategy and criticism as an example of the "winner's curse." Today, PG&E's National Energy Group subsidiary, which owns the NEES and other assets, is in Chapter 11 bankruptcy.
Significant overbuild conditions explain the dearth of sales in other regions. That is especially the case for uncontracted merchant plants in Electric Reliability Council of Texas, East Central Area Reliability Coordinating Agreement, and Southwest Power Pool. In each of these regions sellers received less than $400 per average kilowatt of capacity. The Florida Reliability Coordinating Council, with lower reserve margins, has few transactions, but the two that have occurred have netted high values, averaging $700/kW.
As expected, of the 30 sellers of generation capacity, almost 80 percent were either merchant energy companies or diversified energy companies with merchant businesses. Merchants and diversified energy companies tend to be either exiting merchant generation altogether (e.g., Aquila, El Paso, and Wisconsin Energy), or nominally refocusing on their core utility operations. The top five capacity-selling companies accounted for around 60 percent of the total megawatts sold-selling more than 13 GW of capacity in 11 deals valued at more than $6.5 billion (see Figure 3, p. 49).
Sellers include companies that have experienced severe financial distress during the past two years. But except for Mirant, companies that were unable to restructure voluntarily and were forced into Chapter 11 have sold little capacity. Two notable examples of this are NEG and NRG. Inability to execute asset sales has been in part a source of liquidity problems that are now falling on lenders' shoulders. Thus far, the announced sale of the McClain CCGT plant in Oklahoma by NRG's project lenders is the only transaction related to a bankruptcy proceeding.
On the buy side, more than 30 companies have been active. The top 5 buyers of capacity accounted for more than 60 percent of capacity bought in 10 deals valued at more than $7 billion (see Figure 4). Unlike sellers, buyers have a more evenly mixed profile. Nine buyers have been active in more than one purchase, with Dominion and Brascan Corp., the Canadian financial and real estate company, each involved in three deals.
As a business group, diversified energy companies were the most active buyers. Ten diversified energy companies, in 14 transactions, purchased about 55 percent of the capacity sold. While difficult to delineate clearly, it appears that the vast majority of the capacity purchased was not to serve load within their own utility territory.
Overall, two trends stand out:
- Financial players have stepped in-10 buyers, in 16 transactions, purchased more than 30 percent of the total capacity and are the lead buyers in terms on a dollar value basis ($5 billion).3 Goldman Sachs' two transactions-the Linden, N.J., cogen plant and the Cogentrix portfolio-account for almost 60 percent of the capacity purchased by financial players. As indicated in Figure 4, the company is the number-one buyer in terms of dollar value and number-two purchaser of capacity. Power purchase contracts, with credible counterparties, are the key criteria in both of Goldman's transactions. As Goldman's Managing Director Doug Kimmelman noted in reference to the Cogentrix deal, "The value is in the long-dated offtake contracts, not in the steel."4 Goldman brings capabilities that are currently short in the power market, including a strong balance sheet, credit risk analysis skills, and an energy-trading platform. These offer the firm an important advantage in making good acquisitions and then leveraging their value.
- Taking a smaller but noticeable bite were LSEs, which purchased around 10 percent of the capacity in 11 deals for more than $1 billion. Thomas Chewning, Dominion's CFO, recently pointed out the motivations for this trend: "While wholesale electricity prices are depressed, the regulated retail prices that Dominion's competitive operation seeks to beat haven't come down. Dominion is skipping the middle man by selling its power to its own customers rather than to other competitive suppliers and utilities. 5 (italics added).
This acquisition strategy faces an important hurdle. In mid-December, FERC ordered a hearing to review OGE's announced purchase of the McClain power plant. OGE plans to fold the plant into its rate base. FERC is concerned the transaction may give OGE too much market power.
The last two years have been overwhelmingly bad for many power plant owners and their financial backers. Reserve margins and power prices seem unlikely to improve in the near term for most regions, or even in the medium term for many regions. These are entirely different circumstances from those at the start of the earlier generation asset-sale wave (1997-2001), when the promise of deregulation initiated the sector's boom-bust cycle.
What do the present market conditions mean for future asset-sale activity? Six factors are driving an accelerated pace of asset sales and increasingly downward pressure on the prices of capacity:
- More than 60 GW of capacity on the block includes a number of large portfolios-AEP Texas generation, El Paso, TXU, and Entergy;
- Developers and financiers of capacity coming on line are likely to exit their investment (e.g., Exelon's turnover of its Boston Generating Co. assets to BNP Paribas);
- Power purchase contracts, many above market, will be rolling off in the near term, creating a buyer's market for power and a capacity-owner's nightmare;6
- The writedown of assets to market value, as required by accounting rules, will help narrow the bid-ask spread;
- Financial-distress fatigue will take its toll. The financial wherewithal and patience of many distressed owners and new owner banks are likely to wear thin; and
- Old and inefficient capacity in the rate base is not likely to be retired any time soon. Indeed, this capacity is likely to grow as a result of transfers into the rate base of capacity owned by unregulated affiliates, as well as newly acquired or built plants.7
Strategically, buyers going forward likely will continue making acquisition decisions based on the credit quality of the existing off-take contracts, or on their ability to sign contracts with credible counterparties. Such a strategy is largely a response to the present business environment-characterized by illiquid wholesale power markets, regulatory uncertainty, a heightened sense of credit risk, and the financially weak state of many energy companies. This environment favors investment banks with capabilities to measure, bear, and transfer risk; other financial players with access to capital (e.g., private equity firms); and financially healthy utilities with retail load to support.
- This study does not claim to have accounted for all transactions over the past two years, but is rather a best effort attempt to track all publicly disclosed deals. All information used in the analysis is public. Information on terms and conditions of sales is not complete for all transactions. In particular, the existence, value, and length of power purchase contracts attached to deals or signed thereafter is not consistently available. Consequently, it is difficult to say how many, if any, transactions are "pure merchant" deals. This study also does not include the transfer of assets from project sponsors to the lenders and other investors. Information was sourced from company press releases, SEC filings, and news stories. In total, there were 44 transactions where megawatt capacity sold and dollar value information were available. An additional eight deals were identified but without sufficient details on either sales price or capacity sold. Finally, eight wind transactions were identified, but only two with sale prices.
- Due to a few large or geographically diverse portfolios (e.g., ArcLight's purchase of Aquila assets and Goldman Sachs' purchase of Cogentrix), which make it difficult to value individual plants sold, the data used for both this discussion and the next on sales by region does not cover the full 42 transactions.
- This level of participation is understated given that financial players made up six of the nine sales with insufficient information on dollar value or megawatt capacity.
- Dow Jones, Oct. 21, 2003.
- Dow Jones, Oct. 27, 2003.
- For example, on Oct. 31, 2003, Reliant announced it had updated its estimate of the fair market value of its wholesale energy business. The update was triggered by SFAS No. 142, which requires goodwill to be tested periodically. At the same time, Reliant announced that its evaluation "could lead to decisions to mothball, retire or dispose of assets."
- For example, the state Public Service Commission recently gave Wisconsin Energy the green light to build two 615-MW coal plants in Oak Creek, at a cost of $2.15 billion. The price looks right-the commission endorsed a return on equity for the utility of 12.7 percent a year.
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Plants for Sale: Pricing the New Wave
Financial players and load-serving utilities are looking for power asset deals.