Dynegy Inc. reported a devastating third-quarter loss of $1.8 billion ($4.92/share) last Wednesday, warned of more writedowns in the fourth quarter, failed to offer any earnings guidance going forward, and finally stunned investors and analysts with no conference call to explain.

To make matters even worse, the once-formidable alliance between Dynegy and ChevronTexaco (CVX) was shaken last week, with news that they are negotiating an end to the lucrative natural gas sales contracts scheduled through August 2006 (see related story). However, CVX still is a major stakeholder (it holds 26.5%), and the companies will maintain agreements for Dynegy to process natural gas and liquids through Dynegy Midstream Services.

With the loss of CVX marketing contracts, though, many analysts were questioning Dynegy’s chances for survival. Its stock price, which has hovered below $1 for more than a month, dropped 14% more on Thursday following CVX’s news. By mid-day Friday, the price was moving between 60-70 cents.

In happier times — less than 12 months ago — Dynegy and CVX expanded the natural gas sales agreements, which gave Dynegy the right to purchase nearly all of legacy Texaco’s undedicated U.S. gas and natural gas liquids production for the next four years. The expanded agreement increased the volume of gas purchased by Dynegy to 3 Bcf/d, and increased supply and service for 2 Bcf/d for legacy Texaco facilities and third-party term markets. The contract started Feb. 1.

The agreement now under negotiation, which also was expanded last December, gave Dynegy the contract to process ChevronTexaco’s natural gas. In the upgraded contract, Dynegy agreed to process uncommitted gas production from former Texaco properties as well as ChevronTexaco leases in the Gulf of Mexico.

CVX’s 3Q 2002 earnings statement, released on Thursday, indicated that its U.S. net liquids production for the quarter was 602,000 bbl/d. Net natural gas production averaged 2.406 Bcf/d. Average daily production in the U.S. during the quarter was 9,000 bbl and 49 Bcf. Publicly, neither Dynegy nor CVX have provided specific details of the marketing or processing contracts.

Without the lucrative marketing deal, Dynegy’s retention of the processing rights and its other processing contracts still would make it a player in the midstream services sector, according to some analysts. Standard & Poor’s John Kennedy, who follows Dynegy, noted that the company’s gathering and processing business has “high cash-flow potential,” even though there is a commodity price risk associated with absolute liquid prices. He said that Dynegy’s risk management skills also would “help smooth out this unit’s profits and soften possible losses.” Dynegy’s midstream unit benefits from “significant downstream activities,” said Kennedy, and those activities are “primarily fee-based.”

In a restructuring plan announced in July, Dynegy was working to raise capital by selling $250 million of its natural gas midstream assets to Dynegy Energy Partners LP, a master limited partnership (MLP) that the Securities and Exchange Commission had earlier expected to approve in the third quarter (see NGI, July 1). Dynegy had proposed the MLP to handle fractionation, storage, terminalling, transportation, distribution and marketing of natural gas liquids in North America.

It’s questionable whether the MLP will ever come about, and some believe that Dynegy may not be able to prevent bankruptcy — especially without the marketing contracts from CVX. Raymond James’ analyst Jon Kyle Cartwright surmised that financial analysts may be pressuring CVX to completely pull out from its Dynegy involvement. Said Cartwright, “It’s real ugly if ChevronTexaco walks away from them. That was their real hope.”

Curt Launer, an analyst with Credit Suisse First Boston (CSFB), said, “Recent developments, including negotiations to terminate marketing agreements with ChevronTexaco, represent another negative development in Dynegy’s asset value and potential for recovery.” The analyst said CSFB valued Dynegy’s “hard assets” in generation, utility transmission and distribution and natural gas liquids at about $4 per share, or $1.6 billion, net of debt. “Dynegy shows $6 billion in total debt. In our opinion, Dynegy’s options are liquidation or a debt-for-equity swap in reorganization.”

Perhaps the most devastating comments were made by Prudential Securities analyst Carol Coale in Houston. In her research note, Coale chastised management for not being available for a conference call last week, which she said was on the advice of legal counsel. “We believe there are a number of coinciding bearish factors that are making the company’s going-concern viability tenuous. The key question to be answered in our analysis is whether the remaining business lines will have enough cash-generating ability to service and eventually pay down debt as well as provide enough credit metric support to refinance upcoming maturities.

“We believe the company’s going-concern viability past the April/May 2003 revolver expirations is tenuous,” she added. Prudential is “advising the few remaining fundamental buyers to take what little value is left off the table. It is not a good sign, in our view, when a company allows lawyers to dictate their disclosure with the Street, and the recent news of …renegotiations with 27% shareholder ChevronTexaco tells us that even the physical marketing business has gone bad.”

Dynegy’s quarterly results, announced on Wednesday, included after-tax charges for the following:

“This was a difficult quarter for Dynegy, as it was for other companies in our sector, but one that was expected as Dynegy executed its capital and liquidity plan, experienced unprecedented industry and market conditions and began its organizational restructuring initiatives,” said Bruce Williamson, the company’s new president and CEO, in a written statement. “Dynegy’s results can be attributed to a number of primarily non-cash charges and the loss on the sale of Northern Natural Gas. These charges did not and will not affect the company’s liquidity position, which remains at a level that is sufficient to operate our businesses and meet our customer commitments,” he said.

Reported net loss for Wholesale was $1.26 billion in the quarter, which included after-tax charges of $1.18 billion. Wholesale recognized a $908 million charge associated with the write-down of goodwill resulting from the reduction in near-term power prices, an increase in the rate of return required for investors to enter the merchant energy sector and the company’s decision to exit the marketing and trading business. Within Wholesale, the Asset Businesses, or owned generation segment, reported operating income of $44 million in the quarter, compared with operating income of $187 million for the third quarter of 2001 (after the impact of general and administrative expenses and depreciation and amortization). Customer and Risk Management reported an operating loss of $346 million, compared with earnings of $125 million for the third quarter of 2001.

Dynegy Midstream Services reported quarterly net income of $4 million, including after-tax charges of $4 million, compared to $12 million a year ago. Results were impacted by lower realized natural gas liquids prices and market liquidity, which was “moderately offset by an increase in straddle plant processing volumes,” said Dynegy. For its Transmission and Distribution segment, which includes Illinois Power, Dynegy reported net income from continuing operations totaled $36 million in the third quarter 2002, compared to $26 million in the third quarter 2001. Illinois Power’s performance benefited from seasonal weather, resulting in greater residential and commercial electricity usage.

The company’s communications segment, Dynegy Global Communications, reported net loss of $30 million in the quarter, compared to a net loss of $15 million a year ago. Dynegy said that the unit has limited its capital spending and reduced its operating costs by renegotiating long-term contracts. It also is looking for a partnership for the segment, or would sell the business outright.

As of Sept. 30, Dynegy said it had approximately $1 billion of cash-on-hand, including $189 million in net proceeds from the UK Hornsea sale. The company also had $286 million of availability under its bank facilities and approximately $300 million of highly liquid inventory. The proceeds from the Hornsea sale were subsequently used to pay down part of the bridge financing in October. Total posted collateral, including cash and letters of credit, was approximately $1.3 billion.

Dynegy said it would not offer earnings guidance “due to industry conditions and pending asset sales.” It now is assessing “potential fourth quarter charges, which may include, but are not limited to, charges associated with the recently announced reduction in workforce and organizational restructuring, the cumulative effect related to the recently announced change in accounting principles impacting the energy trading business, and charges associated with exiting certain aspects of the marketing and trading business.”

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