Lynne Kiesling
NRG is purchasing Texas Genco, a generator largely serving Texas markets:
Houston-based Texas Genco is owned in equal parts by affiliates of the Blackstone Group, Hellman & Friedman LLC, Kohlberg Kravis Roberts & Co L.P. and Texas Pacific Group.
Texas Genco has a portfolio with more than 13,000 megawatts of generation capacity. It owns and operates 11 power stations, selling power to wholesale purchasers in Texas’ largest power market, the Electric Reliability Council of Texas.
So what? Seems like a normal transaction. But listen to the back story from this WSJ article on the transaction (subscription required):
The deal also gives the private investors, Texas Pacific Group, Blackstone Group LP, Kohlberg Kravis Roberts & Co. and Hellman & Friedman LLC, a profit of about six times their original investment of nearly $900 million, including the value of the investors’ new 25% stake in NRG. But the rich price could raise criticism among power customers in Texas, who may soon pay higher bills because the assets once were initially valued by state regulators at far less.
Huh? I had to read this through a couple of times, and not because the article is poorly written, because it’s not. When the private investors bought the power plants (mostly coal and nuclear) from CenterPoint Energy, the distribution/wires company serving the Houston area, these assets were worth less (April 2004). Why? Because then, as now, demand for electric power in most hours is high enough that the market-clearing price is determined by the marginal cost of running a natural gas-fired unit. Since then, the price of natural gas has doubled, and that increased input cost gets reflected in the market-clearing price in most hours. It also looks like natural gas prices are going to stay this high for several years. That means that if you own plants fueled by other stuff, like coal or nuclear, if you can sell in those hours you can earn that price. The technical way of saying it is that the inframarginal suppliers earn the market-clearing price determined by the marginal unit in a uniform-price market.
And you know what? In most markets where there are different technologies with different production costs, this is common. Furthermore, in normal transactions if the seller makes a bad deal it’s their shareholders who take the hit, and as shareholders they are in the right position to discipline them before the transaction occurs. But when the production assets are part of the political negotiation to move away from regulation, then there is a mismatch between principal and agent, and it causes friction:
But customers of CenterPoint Energy Inc., the Houston utility that originally sold the power plants, are slated to pay more than $2 billion to make up the difference between what state regulators last year said the generating assets and generation-related contracts were worth and the higher book value carried by CenterPoint.
Consumer groups may now ask how those assets could have appreciated so much in so little time. It’s due in part to the run-up in natural-gas prices. About half the assets being purchased consist of nuclear and coal-fired power plants, which have low operating costs but can sell electricity at the sky-high prices commanded by gas-fired plants, because Texas allows power to be sold at the price commanded by the most expensive source.
At the time the assets were valued, consumer groups said CenterPoint lacked motivation to get the highest price. State utility regulators said last year that the utility hadn’t run the plants to maximize their value, such as by hedging fuel costs and selling power under long-term contracts. The interim private-equity owners enhanced the value by entering into long-term arrangements. They also mothballed money-losing plants.
Critics said that CenterPoint had lacked the motivation to do likewise because it wasn’t allowed to keep any sales profits in excess of book value, under the terms of the state’s utility deregulation law from 1999. Since CenterPoint sold the plants for less than book value, customers are required to make up the difference through so called “stranded-cost” payments that will last 10 years.
CenterPoint also had no incentive to get a selling price greater than book, because they knew the could make up the difference as a “stranded cost”. Yet another instance where having that “stranded cost” net underneath your financial highwire creates perverse incentives.
Stories like this just make my head spin.