A decision by Dynegy Inc. to pull out of a tolling agreement last month will result in lower-than-expected earnings this year and could lead to a $391 million net loss in 2005, the company said Wednesday. Earnings in 2004 are expected to range between $2 million and $22 million (1-6 cents/share), well below an earlier forecast of $75-95 million (20-25 cents).

The dismal earnings outlook was included in a presentation by Dynegy senior management to analysts in New York Wednesday. The news sent Dynegy’s shares tumbling 13% early in the day in heavy trading, and by market close, the stock was down about 10%, or 53 cents, to stand at $4.70. Until Wednesday, the stock had gained almost 22% over the year.

CEO Bruce Williamson and CFO Nick Caruso explained that the weaker results followed the company’s decision in November to pay $117.5 million to a Constellation Energy Group unit to take over a power tolling agreement with Kendall Energy LLC (see Power Market Today, Nov. 19). The transaction took effect Dec. 1, and resulted in Dynegy announcing a pre-tax charge of $115 million in the fourth quarter.

As he fielded questions on the possible sale of more assets, Williamson assured analysts that Dynegy is making a full recovery and will be on stronger financial footing once the tolling contracts have been eliminated. He said the company also continues to be guided by the principles put in place since it began its self restructuring in 2003: to accept responsibility, to restore credibility and to continue to work for all of the company’s investors in the capital structure.

“In the last two years, we had to get equal with each other,” Williamson explained. “We haven’t just been working on refinancing, although that may be what many believe.”

Caruso added, “We had a lot of issues that we had to deal with, and we had to deal with them firmly and expeditiously.” The restructuring is completed, he said, and most of the claims and investigations against the company have been settled.

“We have undertaken initiatives to simplify this company,” said Caruso. Now, Dynegy has a “much, much more simplified capital structure that gives us the ability to do a lot of different types of financial things.” Since 2002, Dynegy has reduced its debt by $3.3 billion, or 37%, and maintained “strong” liquidity, he said.

In 2Q2005, Dynegy will take a $220 million charge because of its planned purchase of Exelon Corp.’s Sithe Energies and Sithe Independence plants for $135 million in cash and the assumption of $919 million in debt. However, the deal will allow Dynegy to cancel out another tolling contract that would have cost about $70 million a year for the next 10 years.

With higher natural gas prices and a slumping power market, the tolling contracts have been a heavy cash drain on Dynegy. Exiting the contracts has been a major requirement to move toward financial viability, said Caruso.

After the Sithe transaction is closed and another toll contract expires in July 2005, Dynegy will have one remaining tolling agreement with a Louisiana power plant that is expected to cost it about $60 million a year until 2017.

Still, Dynegy will be riding a bumpy path at least through 2005. There are four other tolling agreements that have to be dealt with in the coming year, Caruso explained, and Dynegy expects costs in 2005 to be $220 million to settle another power contract. The company also expects to show net losses of $375 million to $391 million in 2005, including $310 million in depreciation costs and debt payoffs.

In 2002 and 2003, Dynegy had combined losses of more than $3 billion, which resulted from Enron Corp.’s bankruptcy and the implosion of the energy merchant sector.

If the tolling contracts and debt retirement costs are excluded, 2005 earnings before interest, taxes, depreciation and amortization will be $450-475 million, Caruso said. Dynegy expects to earn $345 million from its power generation business and $290 million from its midstream operations.

Williamson said the midstream business is strong, and acknowledged that he has been approached by some peers on whether he would sell any of the assets.

“There’s a growing scarcity of significant midstream assets and MLP (master limited partnership) buyers have a continued demand for assets.” Williamson said Dynegy is not interested in selling anything except the tolling agreements.

Alec Dreyer, vice president of the power generation unit, said recovery in the marketplace has taken time, but “we believe capacity markets will develop and mature. We believe you can build a new combined-cycle plant and actually earn a return on capital. And we finally believe the regional markets will be successful. Most importantly, the attributes all must fit together.”

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