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Entergy, Koch Partnering in Gas, Power

Entergy, Koch Partnering in Gas, Power

A new giant is set to emerge from a venture of New Orleans-based Entergy Corp. and privately held Koch Industries Inc. Entergy-Koch LP will be a North American and European powerhouse in electricity and gas, gas transmission and weather derivatives and will be owned 50% by each of its partners. A big focus of the venture will be weather derivatives, of which Koch is a pioneer.

Entergy expects the venture to transform it from a utility with high exposure to price risk into an asset-rich risk management and trading machine. "We were not looking to incrementally step out with more of the same skills, talent or culture we already have," Entergy CEO J. Wayne Leonard told analysts during a conference call. "If we were going to have a partner, it should be someone who can help create fundamental change in the way we think about the market and customer needs, a partner who can help take the physical assets, skills and knowledge we possess and leverage that with complementary skills and assets....."

Wholly owned subsidiaries will be set up for the various businesses, including a pipeline company that will operate the system known as Koch Gateway. Entergy-Koch is expected by its partners to be among the nation's top ten energy commodity traders in terms of combined volumes of electricity and gas. The new company will have assets of approximately $1 billion, including the 10,000-mile Koch Gateway Pipeline, one of the largest gas transmission systems in the Gulf South, and the Bistineau gas storage facility.

The new company will be the first venture between Koch and Entergy, the third-largest U.S. generator of electric power and owner of the nation's largest gas-fired generating fleet. Entergy-Koch, which will have its asset base in the Gulf South and a trading presence in North America and Europe. "The deal looks excellent and worth waiting for, I might add," Morgan Stanley analyst Kit Konolige enthused to Entergy executives during yesterday's conference call. Edward Tirello, an analyst with Deutsche Banc Alex. Brown, said his firm has had a "buy" rating on Entergy for about a year and a half. "It's only looking better."

In addition to Koch Gateway Pipeline, Koch Industries will also contribute the capabilities of Koch Energy Trading, which markets and trades gas, power and weather derivatives. Entergy will contribute its power marketing and trading businesses --- consisting of Entergy Power Marketing Corp. in the United States, and Entergy Trading and Marketing in Europe --- and also cash. Entergy estimates the cash contribution to be $350 million, $150 million of which would be funded with equity and $200 million with debt.

"The complementary strengths being contributed by Entergy and Koch --- in natural gas and in the marketing and trading of power and other energy commodities --- bring a unique set of resources to the new company," Leonard said. "Entergy-Koch will have the assets and the scale to compete and grow. It will trade volumes in excess of 100 million MWh of electricity annually and 5 Bcf of gas daily - a scale that is generally recognized as necessary for ongoing profitability. For Entergy, the new company will not only contribute to our earnings growth on its own but will offer risk-management tools to our existing businesses."

In March Entergy confirmed it was involved in talks regarding a possible joint venture between its wholesale electricity trading unit, Entergy Wholesale Operations, and another company (see NGI March 27). In December Entergy unveiled a five-year, $9.8 billion capital investment plan. "The next five years will find Entergy through its transition period and well into competition in most, if not all of our service territory," Leonard said at the time.

Leonard last week told analysts the venture "...will transform Entergy from a company viewed by some of you as struggling to manage the price risk that goes with being the third largest power producer in the country, having 32 combustion turbines on order, and being the nation's largest natural gas purchaser into a legitimate market-maker with an interest in substantial assets in both power and natural gas, a skill level equal to anyone in the industry, and information systems that are in many ways substantially ahead of anyone we are aware of in the industry. Our people, having traded most shops in Houston, including at Enron, and on Wall Street, will tell you that Koch's information systems provide a substantial competitive advantage to anyone they are aware of."

Entergy-Koch will benefit from Koch Energy Trading's leading position in energy commodities markets, including weather derivatives, and from Koch Energy Trading's highly disciplined commodity trading controls, policies, procedures, systems and infrastructure. The new company will also benefit from Entergy's capabilities in domestic and international power marketing and trading. Entergy-Koch will be able to provide customers a broad range of commodity sources and options, including gas, oil, coal and power, weather derivatives and additional risk management tools.

The company also will market the power of and provide risk management and trading services for Entergy's existing and future merchant plants. Entergy will retain its growing merchant generation fleet, enabling it to establish a singular focus on developing profitable merchant plants while benefiting from its relationship with Entergy-Koch's skilled trading and risk management team. Entergy Corp. is expecting the venture to contribute 25 to 30 cents per share to its earnings in its first full year of operation.

Koch Energy Trading is a market leader in weather derivatives, currently accounting for about 30% of such trades. Leonard said Entergy initially wanted no part of the weather derivatives business, and Koch wasn't willing to give any of it up. However, now it is one of the most exciting components of the deal, he said. "Weather derivatives are currently estimated to be a $3 to $5 billion market that Koch is just beginning to scratch the surface of all the potential applications that these products offer."

While the word "derivative" is still considered pejorative in some circles, Entergy is one of many who are overcoming their apprehensions. "I think the word derivatives scared them," said Kyle Vann, currently senior vice president of Koch Industries and the head of Entergy-Koch. "I think from our standpoint there are a couple issues that changed. One, they saw how profitable the business could be. Koch initially wanted to keep it in Koch Industries, but I think the weather derivatives group was most suited to be with the gas and power area..."

Through the deal with Entergy, Koch gets a physical fit with the company through Koch Gateway Pipeline, which serves many of Entergy's gas-fired generating facilities. Once the venture is up and running, initial focus will be on strengthening gas supply for both parent companies and growing a national presence in gas through the storage and marketing businesses, Vann said. The venture will provide storage management to LDCs. Power project development also will be a priority. And Vann said a big focus will be placed on cross-commodity trading, embedding weather derivatives more and more into other commodities to lower the risk in both. Finally, moving the weather and other trading businesses to Europe is a goal. Entergy Marketing and Trading in London is trading gas and power there now, and the venture will become the entity that manages those operations.

The venture will be headquartered in Houston. Formation of the new company is subject to completion of some final documentation, and the venture will require board approvals. Approval also is needed from the Federal Energy Regulatory Commission and the Securities and Exchange Commission. The approval process is expected to take six to nine months.

Joe Fisher, Houston

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