Kenneth Simon, Dickstein, Shapiro, Morin & Oshinsky
As the “new breed” of energy companies—Enron, Dynegy, Mirant, Calpine, AES, Reliant, Williams, NRG and others—withdraws from trading activities and sells off assets to shore up balance sheets or repay creditors, another group of companies is poised to take their place. However, these emerging energy players are not traditional regulated utility and pipeline companies, which either face liquidity and balance sheet problems of their own or never embraced the new energy economy.
The new “new” players instead are firms with the cash to pick up the assets and trading books of troubled companies at large discounts, the discipline to manage investments and implement trading strategies effectively, and the appetite for new ventures. Unlike the traditional regulated companies and the now troubled new breed of entrepreneurs, these investors view energy investments as a means to diversify their equity holdings. They come in all shapes and sizes: conglomerates, insurance companies, hedge funds, private equity funds, and affiliates of investment banks and commercial banks. To some extent they participated in the energy industry all along, but mostly as secured lenders and deal arrangers. That’s all changing now.
When Warren Buffett and Berkshire Hathaway invested in a traditional Midwest utility, MidAmerican, the investment community noticed, but did not follow. Buffett’s investment preceded the crash in the new energy economy, so bargains were hard to find, but Buffett was moderate in his investment objectives. Regulated assets earning 11 or 12 percent returns on equity were acceptable to him in an economy where double digit returns were becoming increasingly difficult to find—especially for investments of the size Berkshire Hathaway was prepared to make. Anyone in the stock market the past few years can appreciate Buffett’s foresight.
Buffett and MidAmerican next turned to buying natural gas pipelines. Pipelines offered the more secure returns Buffett sought, and a manageable regulatory approval process. This time the investment community followed Buffett’s lead, seeking out contracted energy assets, such as pipelines, electric transmission lines and power plants with long-term off-take contracts. AIG Highstar, an equity fund and subsidiary of American International Group began snapping up gas assets. On the electricity front, GE Capital and TransElect, and Kohlberg Kravis and Trimaran Capital Partners (a private New York asset management firm) bought electric transmission assets; ArcLight Capital Partners (a private equity firm linked to John Hancock) purchased a small fully contracted power plant in Texas.
Another group of companies is beginning to emerge in the energy trading business. For the most part, they are not the new equity investors, but rather professional traders, with discipline and strategies forged in other markets. Some financial players have been trading energy since the new energy economy was born—Morgan Stanley, for example. The new arrivals include UBS Warburg, which bought Enron’s back room trading assets. Also last year, a number of banks and hedge funds filed market rate tariffs with the FERC, including UBS AB, Bank of America, and hedge fund affiliate Citadel Energy.
My own experience suggests that the reported deals are only a small part of the action in the market now. After more than twenty years representing independent power producers and traditional gas and electric utilities, much of my time last year was devoted to representing new market participants. The list of private equity funds searching for energy investments is long and robust. Many other investors are actively looking for opportunities. Generally these investors shun merchant generation as far too risky and unprofitable today. It is also not clear whether the new traders will re-establish more robust energy markets, or whether largely bilateral market activity is here to stay. I suspect, however, that today’s high gas prices will return to much lower levels in the next few years and new long-term fuel supply and power sale contracts will become both feasible and desirable. Formerly merchant generation will re-emerge as more fully contracted generation, with the balance of the output perhaps traded in more disciplined energy markets. When this opportunity evolves, the new investors will be there to take advantage of it, as may some of the old “new breed,” if they can hang on long enough.
Simon is a partner at Dickstein, Shapiro, Morin & Oshinsky LLP, and he is co-head of the firm’s corporate & finance practice group. He may be reached at 202-828-2227 or at firstname.lastname@example.org.