While merchant industry “consolidation is inevitable,” NRG Energy CEO David Crane doesn’t see much action anytime soon. “I look around to see people to consolidate with, I see a lot of debt.” And, having emerged from bankruptcy with “a balance sheet on the edge of being sustainable,” Crane is not inclined “to go back into balance sheet soup.”
However, Crane, speaking at a Merrill Lynch conference recently, pointed to the emergence of Texas Genco as “an avowed consolidator,” a major event that he said, “changes the game a little bit.” NRG, which doesn’t have any legacy issues, is an ideal player in the consolidation game, Crane said, especially now that some of the big financial companies are getting into the business. NRG has assets but not sufficient credit to trade around the assets, so it’s a perfect fit for a merger with a financial company.
Also, its baseload coal-fired assets are a plus. Crane viewed as “good news” the moderate summer, noting that combined cycle gas-fired, 7-heat rate plants, which are in surplus supply and may only run during the summer months, suffered much more from the lack of really hot weather than did NRG’s coal-fired plants.
NRG’s coal-based generation also offers relief from gas volatility risk. Crane said that on a recent visit to the Louisiana public service commission, related to NRG’s coal generation plant in the region, he was asked by the regulators how they could get more non-gas power in the state. “I said, just give us a 10-20 year contract and we’ll build another coal unit. I think it’s interesting that in Louisiana, the home of the Henry Hub, where they have no basis risk, they’re so worried about gas prices and desperate to diversify their sources of generation.”
In the merchant industry for consolidation to occur there still are things that “need to be gotten under control. A lot of companies have gone a long way” toward that goal, but, for instance, some of the big European companies that might be expected to get into the U.S. market by attempting ventures with some of the recovering U.S. firms, are still skeptical, Crane said. There are still too many legacy issues, such as power purchase contracts that “it’s difficult for an outsider to value.”
Dynegy CEO Bruce Williamson, appearing on the same panel, agreed that “everyone needs to clean up their own mess, cut their own costs.” He estimated that when the process is finished most merchant companies will have about 10-15,000 MW operations, plus side businesses, such as Dynegy’s midstream businesses that on a megawatt equivalent basis will put most companies in the overall 10-20 MW range.
If a company is set up to manage assets of about that size, “you can easily handle two and three times the megawatts and not increase any costs. Also, there’s the opportunity to cut costs administrative costs through a merger.” Williamson pointed to the “fixed costs of running a public corporation,” which he said could run into “some pretty lofty numbers.” Both Williamson and Crane mentioned the new Sarbanes-Oxley rules and public auditing fees as adding substantially to costs. “If you put two companies together, you’re probably not doubling it, it’s probably about the same amount; it’s the ‘one plus one is equal to one’ sort of thing.”
Williamson pointed to the consolidation of E&P companies that started in the late 80s as an example of what he sees down the road for the merchant industry. “It’s going to happen here.”
Questioned as to contracting for the Dynegy/NRG joint venture, Westcoast Power, whose contract with the California Department of Water & Power runs out at the end of the year, Williamson said it was possible they would go into 2005 at risk, or “at merchant.” Westcoast Power has submitted proposals to a SoCal Edison RFO and was doing another proposal for PG&E. “We will submit bids at a level that makes sense.” If those are not successful “we can float. The range of potential outcomes in California is so broad right now.”
There is concern for the state since California had a relatively cool summer. “California’s biggest risk was not a hot summer, but a cool summer. They got by and they didn’t fix anything,” Williamson said. “The governor’s energy department needs to make changes in the regulatory paradigm…they need to fix the overall regulatory environment,” but the pressure was not there this summer to accomplish that.
Meanwhile, Dynegy has succeeded in restructuring to reduce costs, reducing debt and pushing much of the remaining debt out to a time when power commodity prices are expected to recover. Debt has been reduced from $8.8 billion at the end of 2002 to $5.5 billion, and Dynegy has “substantial liquidity and cash on hand, with some upside cash flow potential” from its gas liquids, midstream business. Completing the sale of Illinois Power allows the company to pay down more debt, cut its basic costs more than in half and move into its simplified business model, with two lines of business, power generation and the natural gas midstream.
Williamson offered recent highlights from both its lines of business. In spite of a relatively cool summer, Dynegy’s Midwest generation fleet had its second best volume production month in the history of the 30-year old coal-fired plants. He expects to continue to see low cost power plants as the “early winners, putting out more volume and then watching prices creep up and our margins expand.” The company’s largest power generation plant, the Baldwin plant, ran straight through, full out for the month of August without any interruptions.
Dynegy also has had very good results this year with its gas midstream operations. Starting July 1 with the crude oil run-up that has dragged up the heavy end of gas liquids pricing, “and we now have a positive frac spread, very much akin to if we were to have a positive spark spread. All those straddle plants that had not been running are now turned on.” Based on the improved gas midstream results Dynegy expects to be raising its 2004 guidance significantly, Williamson said. Through the first half of the year, before the oil price rise began in earnest, the liquids business was generating $6.80 for every $1 of maintenance capital.
Based on the NERC 2004 summer assessment, Williamson sees power plant recovery for the Northeast and Midwest coming in about 4-5 years.
Currently the company is concentrating on converting the rest of its Midwest coal generation fleet to Powder River Basin coal.
Both Dynegy and NRG currently are converting their coal plants, where feasible, to Powder River Basin coal, which will cut costs and emissions.
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