Prices for merchant power assets appear to have halted a three-year free fall and more than 100,000 MW of electricity generating capacity -- the amount bought and sold over the past three years -- is expected to change hands in the coming 12 to 18 months, according to "Terra Firma: Merchant Power Plant Prices Hit Bottom," a new research report by Cambridge Energy Research Associates (CERA), an IHS company.
CERA notes that when U.S. power plant sales began to gain momentum in mid-2002, lightly contracted or uncontracted merchant plants generally were not included in the deal flow. That situation has changed since the beginning of 2004, with over 80% of nearly 58,000 MW in announced transactions coming out of the merchant sector.
"While this resurging interest in merchant generators reflects more than just a dwindling availability of contracted assets in the market, it does not necessarily point to an immediate and broad recovery for the merchant power sector," according to CERA Director of Asset Valuation and report co-author Patricia DiOrio. "Bid-ask spreads have tightened and an increasing number of announced deals are closing, indicating a bottoming of the asset value cycle," she said.
According to CERA's research, more than $20 billion in private equity has been earmarked for energy investment. Financial sponsors and plant operator/financial investor partnerships have, by far, been the most active buyers in the sector, participating in over 60% of power generating asset transactions, both contracted and merchant, from the beginning of 2004 through September of 2005, CERA noted.
Although financial investors have differing objectives, they typically tend to own power assets for a shorter time than strategic owners such as utility affiliates and independent generating companies. "The increasing participation of financial investors points to the deployment of additional capital in the market, increasing competition for assets, and a sustained near-term and future transaction volume. In projecting 100,000 MW of near-term transactions, we considered assets currently owned by financial investors, given their shorter-term objectives," according to DiOrio. "In addition, we considered assets transferred to creditors, further portfolio optimizations by competitive generators, and recent 'for sale' announcements."
Over the longer term, utilities, competitive generators and utility/competitive hybrid companies will be the natural group of next owners for merchant generating capacity, according to the report.
Pricing trends indicate that merchant plant valuations will continue to show an increasing locational bias, with plants in capacity-constrained, deregulated markets selling at higher prices than merchant facilities located in regions with excess capacity and more tightly regulated markets.
"CERA views regulatory resolution in resource adequacy markets as the most important driver of merchant asset values going forward," DiOrio said. "There is no consensus on an effective mechanism for sending appropriate price signals when new supply is needed and for compensating existing generators such that cost-of-service type arrangements are no longer required in deregulated markets. Resolving the structure of capacity markets is critical to solidifying merchant asset values. In addition to capacity prices, working off the generation overbuild, relative fuel prices, transmission investment, and environmental regulations round out our list of primary merchant asset value drivers."
She said that with ownership of another 100,000 MW "likely to change hands in the next 12 to 18 months and asset values no longer in a free fall, timing and the accurate assessment of market fundamentals and eventual recovery has become critical to buyers and sellers alike."
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