POWER POINTS:Merchant Energy May Have Already Hit Bottom
By MARK GOLDEN
A Dow Jones Newswires Column
NEW YORK -- Despite continued dire warnings about merchant power companies, U.S. wholesale electricity prices indicate that the sector has reached a bottom and prospects for recovery aren't that bad.
In an overview of the sector last week, Standard & Poor's analyst Peter Rigby wrote that the trends of declining stock and bond prices "combined with falling credit ratings, depressed power prices, Federal Energy Regulatory Commission and Securities Exchange Commission inquiries, and troubles with creditors, may portend failing business plans, if not bankruptcy."
But bulk power prices are higher than they were six months ago, and merchant energy company stock prices have about doubled on average since their lows in July. Those stock prices are still pathetic, indicating that companies like Calpine Corp. (CPN), Mirant Corp. (MIR) and Williams Cos. (WMB) aren't valued as going concerns.
Maybe they should be. Forward power prices in much of the country have returned to the level where generating companies can almost cover their fixed costs. Contracts for power next year in northern California delivered around the clock are trading at $37 a megawatt-hour, about $6 over the price of natural gas and other variable costs. That's still a few dollars per megawatt-hour shy of what most companies need to cover their fixed costs, but it's about $5 higher than it was six months ago.
The Northeast is also looking better for independent generators, though prices in Texas and the Midwest haven't risen as much.
A Skeptic
After companies add in much higher profits from any long-term contracts sold last year, plus income from ancillary services and trading, merchant power looks like a viable business, according to one private investor looking at the sector.
The high-priced long-term contracts start to roll off next year, but power prices rise for 2004 through 2010. The entire curve could continue to rise, because almost no new power plants will make it to completion if construction didn't start earlier this year.
Not everyone agrees that the worst is over for the sector.
"Many of these companies probably haven't hit bottom," independent analyst Paul Patterson said. "This is just a taste of how bad things are going to get."
There's too little volume is going through the power market right now to conclude that prices are really rebounding, Patterson said. He still expects some bankruptcies in the industry and doesn't generally believe what many companies say about their future profitability.
"These companies have too much leverage, a lack of liquidity, steeply declining commodity prices and accounting methodologies that leave a lot to be desired," Patterson said. "Even if they are able to escape bankruptcy, that doesn't mean there will be much residual value for stockholders."
The companies could still sell more stock, further diluting earnings already hurt by asset sales and low commodity prices, Patterson said. He pointed to Nortel Networks Corp.'s (NT) sale of convertible bonds when its stock was trading in the single digits, as merchant energy stocks are now.
Maturing debt obligations obviously weigh heavily on many merchant energy companies. Reliant Resources Inc. (RRI), for example, has almost $8 billion maturing by the end of next year, according to a summary by Salomon Smith Barney, while Dynegy is looking at $3.7 billion.
Contract Sales A Test
For now, the companies are selling assets to raise cash, and prices below book value offered for natural gas pipelines aren't encouraging for potential sellers, S&P's Rigby points out. The market is flooded with "for sale" signs, though generators haven't caved in to the low bids for power plants.
Before they do so, they may sell profitable long-term supply contracts to third parties. At an investor conference in New York this week, Duke Energy Co's. (DUK) head of energy services, Harvey Padewer, was asked repeatedly if Duke would be acquiring any power plants from distressed companies. He responded that Duke is more likely to buy contractual assets than power plants.
If merchants manage to sell some of their contracts at something close to their net present value, that would be the clearest signal that the worst is over for the industry. It would demonstrate the industry isn't going away and that some of these companies did take advantage of the boom part of the cycle.
And if forward prices make a final push to the level necessary to cover fixed costs, banks could renew debt facilities. That is their business, after all - lending to going concerns. Maybe not all of the companies will get to that end point, but most now look like they will. Mirant and Calpine seem to get the most votes of confidence.
Even Patterson wouldn't short the sector's shares at this time.
"There's still bankruptcy potential, but it's way too easy for prices to jump from $3 to $5 at these levels," he said.
That does sound like a market bottom. -By Mark Golden, Dow Jones Newswires; 201-938-4604; mark.golden@dowjones.com
Updated September 6, 2002 3:15 p.m. EDT |
