Depending on how well the U.S. economy fares going forward, Dynegy Inc. will not only recover, but will be an active player as the power sector consolidates, CFO Nick Caruso said last week.

Speaking at the RBC Capital Markets North American Energy and Power Conference in Boston, Caruso said Dynegy’s power generation portfolio already is benefiting because of its diversified 12,713 MW of net generating capacity, spread across coal, dual-fuel and natural gas units. And, it holds “significant positions in favorable NERC regions.”

But Caruso, who came out of retirement 18 months ago to work for Dynegy after spending 30 years at Shell Oil Co., said overall, the power market’s recovery will take time.

Dynegy management believes the sector’s “Phase 1” recovery actually began in the first quarter of 2003 through “weather-induced demand spikes,” and these extreme weather conditions drove “unusually high demand,” with power prices driven up at the margin by high gas prices.

Phase 2, which occurred in the first quarter of 2004, offered the power market “cost-advantaged volume increases,” said Caruso. These increases were “normal weather-driven demand that resulted in “somewhat weaker power prices.” It also led to “far lower cost of operations, with coal and dual-fuel generation versus gas-fired assets.”

In Phase 3, which has not yet occurred, there will be “sustained average increases,” characterized by increased capital spending and some permanent overall demand increases, said Caruso. There also will be a “widening gap between power prices and the cost of using coal and dual fuel,” which he said would also be known as a “dark spread,” that will create “early winners.”

The “positive gas-spark spread ” in Phase 4 will follow a sustained strong economy, said Caruso, and at this point, Dynegy holds distinct advantages. “Gas-fired fleets will start to develop stronger results due to a fall off in gas prices, and gas-fired peakers will kick in, driving earnings further upward.” In this final phase, he said, Dynegy has three opportunities to increase its earnings: “dark spread, spark spread and peaker use.”

Rhetorically asking if Phase 4 can actually happen, Caruso noted that 2004 is a forward price. “We don’t need to get back to 2001 prices, which averaged $70. We’re still 35% higher at an average $43 price than the ‘recovery’ price of $58 on average.” When Phase 4 kicks in, he said there will be “opportunity if the market presents itself.”

Management meetings at Dynegy once again include the “G word,” or growth, Caruso said. And at some point when the economy is stronger, Dynegy once again will be considering ways to increase its strength.

“We’ll be a player, and there will be some consolidation,” he said. Currently, there are 14-15 “players,” but in the long term, Dynegy management is forecasting five to seven major generators.

“To say that we would assume we even have enough cash to buy any assets, I do not think we will be buying any assets,” said Caruso. “We would look for a consolidation partner” to reduce expenses on such things as insurance. “A combined company would not need more insurance. Also, it seems like every company has between $1-1.5 billion in liquidity and a combined company would still only need about $1 billion in liquidity.”

But recovery in the sector will take time, Caruso warned. Within the NERC region, where most of Dynegy’s units are located, the company is forecasting NYISO’s estimated recovery at three-to-five years; MAIN’s and ECAR’s, four-to-six years; SERC-VACAR’s five-to-seven years; ERCOT’s six-to-nine years; SERC-Southern’s nine-to-11 years; and SERC-Entergy’s 10-plus years.

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