Aggressive bidding sustains sellers market for generation

Jeff Bodington

Bodington & Co.

AmerGen, Calpine, El Paso, NRG, PP&L Global, Sithe-these are a few of the most active buyers of generating capacity in the United States during 1999. The total of widely announced acquisitions during 1999 was nearly 36,000 MW. As has been the case since the mid-1990s, bidding has been aggressive, prices can appear high, and it remains a seller`s market for generation. In addition, 2000 looks as though it will be as busy as 1999.

The accompanying table lists the publicly announced transactions. This information is based on public sources and reflects most, but not all, sales during 1999. In addition, it includes sales that were announced during 1998 but did not close until 1999 and sales that were announced during 1999 but that had not yet closed by year`s end.

Divestitures keep rolling along

The sale of nearly 36,000 MW involved 170 projects, both divested utility capacity and qualifying facilities (QFs).

Divested utility capacity accounts for the lion`s share of activity: 101 projects, over 32,700 gross MW, and over 31,600 net MW. At pace with increasing deregulation, this is approximately 50 percent above the total for 1998. Most of this is due to divestiture of utility-owned assets. Consolidated Edison, Duquesne, GPU, Niagara Mohawk, Northeast Utilities, SDG&E and others sold off projects they had owned for decades. As has been the case for at least the last five years, unregulated subsidiaries of utilities have been the most active buyers. Northeast Generation, NRG, and PP&L Global are examples of this type of buyer. Sithe`s purchase of GPU`s generation is an example of an independent power company that is an active purchaser of divested utility assets.

Only a few years ago, transactions involving nuclear facilities were by many to be considered unlikely. Several utilities had tried to sell interests in their nuclear units without success. Costs appeared too high for viable operations in evolving competitive markets. Environmental, spent fuel, and decommissioning-related issues seemed intractable. Last year AmerGen purchased Oyster Creek, Clinton, a unit of Three Mile Island, and the Vermont Yankee facilities. Great Bay acquired EUA`s share of Seabrook. RG&E purchased Nine Mile Point from Niagara Mohawk and NYSE&G. PSE&G and PECO also purchased more of three units they already partially owned. Entergy bought Boston Edison`s Pilgrim station. In sum, transactions involving nuclear projects have quickly become common. Buyers have found ways to manage the risks and they see projects with competitive marginal energy costs.

While dwarfed by the total MW of divestiture-related sales, the market for QFs was also active. The net equity MW traded totaled approximately 4,100 during 1999. Calpine and El Paso Energy were aggressive buyers during 1999. Calpine purchased Cogeneration Corporation of America from NRG and interests in two geothermal projects in California. El Paso Energy purchased projects from Enron, PSE&G Global, Bonneville Pacific, Dynegy, and CalEnergy.

While a trend toward consolidation and large players with big balance sheets is clear, independent and niche developers were also active. Delta Power, KMS and UAE purchased projects during 1999. Diverse projects mean that there are continuing roles for owners with different sizes and skills. Consolidation and the demand for a big balance sheet have affected primarily the greenfield-development and utility-asset-divestiture segments of the market for power projects, and there is a continuing role for smaller developers who provide unique value added to QFs. In addition, much work remains to be done on QFs. Of the approximately 6,000 QFs initially operating in the United States, approximately 500 have been bought out or otherwise shut down, hence about 5,500 remain to be operated through their contract terms or bought out.

The table shows only transactions concerning operating facilities, but the market for greenfield opportunities is also active. Both Calpine and FPL Energy purchased the rights to projects that were in the late stages of permitting. Bodington & Co. advised Tejon Ranch on its lease of a site to Enron for the Pastoria project in Southern California.

Aggressive bidders keep market alive

Auctions of QFs, divested utility and merchant projects have all drawn multiple proposals from well-qualified bidders. The market in each of these three segments remains a seller`s market.

Independent power began in the 1980s with after-tax returns over 20 percent, and increasing competition drove returns down by the mid-1990s-in some cases, down to the single digits. Returns remain at these levels for high-quality QFs. Divested utility and merchant projects involve more risk than most QFs, and buyers are requiring higher returns. Thus prices are lower, but not much. After-tax returns are in the range of the low to high teens. As soon as these divested asset and greenfield project markets materialized, competition became intense, so most buyers never saw the potential to earn returns above the mid to high teens. Higher returns are earned only by taking extra project risk, increasing financial leverage, earning fees on management and operations and maintenance, fitting a project into a large electric and gas trading operation, or realizing other unique and option values a project may present. In addition, valuation of power projects has been evolving. Initially driven by cash flow, public company pricing ratios have become more important. P/E and P/EV are now common tests of value. Accretive acquisitions sell well to a Wall Street driven by year-on-year earnings growth.

In addition, valuation is evolving and two means of adding extra value are receiving extra current attention. The first is the value of a power project in volatile gas and electric markets. Sophisticated models are being developed to reflect what an owner may earn by selling into spot, forward, option and ancillary service markets. Second is the opportunity for bulldozer repowering. A few QFs and many divested utility projects represent sites with fuel, electric, water and some permit infrastructure in place. Old and inefficient projects can be bulldozed and replaced with smaller, cleaner, and more efficient generation.

This year appears to be as busy as last. Several more divestitures are planned. Sithe is selling the 21 power projects it purchased from GPU last year to Reliant for $2.1 billion. MCN Investment is selling its QFs and EWG interests due in part to the merger of its parent with Detroit Edison. Calpine has purchased the development stage 540 MW Hermiston project from IdaWest Energy Co. and TransCanada Pipelines Inc. PowerGen PLC is in the process of acquiring LG&E for more than $3 billion.

Jeff Bodington is president of Bodington & Co., an NASD broker/ dealer that advises buyers and sellers of power projects.

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