NRG Energy's proposed $287.5 million cash acquisition of Reliant Energy Inc.'s retail electricity unit in Texas would give the company a leading retailer in the deregulated Texas market, considered to be the most competitive in the nation. What effect the transaction would have on Exelon Corp.'s proposed takeover of NRG remains a question, but industry executives noted that the deal addresses credit issues that have buffeted Reliant and the rest of the industry.
Houston-based Reliant's retail arm has 1.8 million customers, primarily in Texas. Under the transaction Reliant would continue to produce power, with 14,000 MW of capacity outside Texas. NRG bought 11,000 MW of capacity from Texas Genco in 2006, and it currently is the second largest power producer in Texas behind Luminant, which has 18,300 MW of capacity.
NRG CEO David Crane said in a conference call last Monday the transaction would provide Reliant with much-needed cash and would give the Texas market a retailer with a "more solid financial foundation." The deal is expected to close by the end of June.
Reliant last October said financial pressures were forcing it to consider alternatives that included selling its retail business unit (see Power Market Today, Oct. 8, 2008). Reliant in December completed the sale of its northeastern retail subsidiaries to Hess Corp. (see Power Market Today, Jan. 2).
"This transaction creates value for our shareholders and eliminates the capital requirements of the retail business," said Reliant CEO Mark Jacobs. "Going forward, Reliant will be well positioned with a diversified portfolio of generating assets, a strong balance sheet and ample liquidity." Reliant plans to use the cash from the NRG transaction to pay down debt.
The timing of the deal was enough to strike two scheduled Reliant speakers from the lineup at KEMA's 20th Executive Forum: The New Energy Frontier in Houston last week. They asked to be excused because of the pending transaction. Remaining speakers had plenty to talk about as "this financial crisis is creating a massive burden on the health of the retail energy sector," said Taff Tschamler, KEMA director for retail energy.
Compared to other states that have pursued retail electricity deregulation, Texas is seen by the industry as an overwhelming success. According to KEMA research, 47% of the nation's entire competitive retail market is in Texas, Tschamler said. About 5.5 million Texas retail consumers are served by competitive providers. New York state is No. 2 with 800,000 customers served by competitive retail providers. "It's Texas and everybody else," Tschamler said.
The Reliant unit "fits like a glove, and we intend, now that we are in a position to own retail in Texas, to pursue retail in Texas aggressively," Crane told energy analysts.
The Reliant transaction was not designed to scuttle Exelon's bid to take over NRG, said Crane. The combined Texas businesses, he told analysts, would reduce NRG's need to buy and sell power from other counterparties, reduce transaction costs and cut its exposure to credit risks.
As part of the transaction, NRG renegotiated a $200 million credit agreement with Merrill Lynch to support Reliant's retail business for up to 18 months, ending litigation between Reliant and Merrill over their current credit arrangements (see Power Market Today, Dec. 30, 2008).
Direct Energy President Phil Tonge called the NRG-Reliant deal "a perfect example of the industry response" to the credit crisis.
Tschamler said 2008 saw a continuing decline in the financial health of electricity retailers, including in Texas, which saw a number of providers fail, forcing residential customers to scurry and switch suppliers or be assigned to high-cost providers of last resort (see Power Market Today, July 2, 2008). But 2009 will be a year of opportunity for companies that have adequate credit, Tschamler said.
These companies can look forward to improved margins and potential market share gains, he said, but also rising customer credit risk and per-customer consumption declines. "I think the outlook for those with credit is quite favorable, actually," he said. Those without credit will likely fail or be consolidated, he said.
Retailers can face extreme financial pressure from collateral calls when commodity prices decline, putting their hedges out of the money, speakers at the KEMA conference noted. The NRG-Reliant transaction is further evidence of a trend in which retailers are backing up their portfolios with generating assets to insulate themselves from market volatility.
Texas consumers have been pestering their elected representatives about high electric bills, and there's a risk that some lawmakers might cave in to pressure to reregulate the Texas retail electric market, state Rep. Phil King (R-Weatherford) warned the audience at KEMA conference.
"I think there is a significant possibility [of movement toward reregulation] because what's happening is consumers have been wearing out the legislators -- good, free-market legislators -- with, 'Why are my electric bills going up?' And then some...say, 'See, they haven't gone up on the regulated side.' You've got a number of groups that have different motives for why they want to do things. So I think it's a significant possibility. I'm not going to say it's a probability. I think you'll for sure see some legislation on price plans, maybe, or something like that."
King asserted that while regulated rates of Texas municipal and cooperative utilities haven't gone up, they aren't coming down either and that deregulated markets are still the best bet for consumers.
The entire retail electricity sector is in for "a tremendous amount of change," said TXU Energy CEO Jim Burke, and Texas is seeing it sooner than the rest of the market. Deals that combine retail providers with generating assets -- like the NRG acquisition of the Reliant retail business -- make sense, according to Burke, as the industry is seeing greater synergy between the two than originally thought.
Constellation NewEnergy President Michael Kagan said he expects some of the smaller retail providers that offer niche services not provided by larger players to consolidate. Larger providers that haven't managed credit risk will be broken up or bought, he said.
For its part, Exelon is evaluating the NRG-Reliant announcement, CEO John Rowe stated. Recently Exelon claimed that NRG shareholders had tendered 51% of their common shares (see Power Market Today, Feb. 27).
"NRG hasn't provided enough information about its deal with Reliant to enable us to make an informed judgment about the impact of that deal on Exelon's pending offer to acquire NRG and the resultant impact on the value our deal creates for shareholders," said Rowe. "Nonetheless, given the announcement that Reliant may become part of NRG and our support for retail energy markets, we will certainly evaluate how all the pieces fit together in our proposed transaction."
Exelon, he said, "supports competition in both wholesale and retail markets. We believe under the right circumstances that an Exelon-NRG-Reliant combination would be good for competition in Texas -- particularly because we bring a stronger balance sheet to the table -- as well as good for the NRG and Exelon shareholders."
Exelon and NRG shareholders have to understand whether the Reliant agreement is value-enhancing, said Rowe. "Exelon has repeatedly invited NRG to engage in a mutual due diligence process to verify the value created from the combination of Exelon and NRG and identify additional value that might support further discussions about the price put forth by Exelon. To date, NRG's management and board have refused."
NRG's deal with Reliant "and the recent legal action by the U.S. Environmental Protection Agency regarding one of NRG's Louisiana plants reinforces the need for due diligence," said Rowe. "It simply underscores why we urge NRG shareholders to demonstrate their support for an Exelon-NRG deal."
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