Private equity has become the go-to buyer for power plants.
Most recently American Electric Power agreed to sell four plants totaling 5,200 MW to a joint venture of Blackstone and ArcLight Capital Partners for $2.17 billion.
The sales include three gas-fired plants – 1,186-MW Lawrenceburg in Indiana, 840-MW Waterford and 507-MW Darby, in Waterford and Mount Sterling in Ohio – and one coal-fired plant, the 2,665-MW Gen. James M. Gavin plant in Cheshire, Ohio.
In December, ArcLight announced that its Eastern Generation portfolio company acquired 4,800 MW of mostly gas-fired plants in New York, Michigan, Illinois and Ohio from Tenaska Capital Management
Earlier deals include Energy Capital Partners’ acquisition of three plants totaling 3,398 MW from Dominion Resources for $450 million, according to market sources, and Riverstone Holdings’ acquisition, through its Raven Power portfolio company, of 2,648 MW of plants in Maryland from Exelon for about $400 million.
The list goes on, and if sales between private equity firms or post-acquisition deals are included — such as Dynegy’s buyout of Energy Capital Partner’s stake in their 9,058-MW Atlas Power joint venture, or Riverstone’s plan to buy back 16,000-MW Talen Energy’s stock, taking the generator private just one year after its initial public offering — list is even longer.
“This is part of a continuing trend by hybrid utilities to lower their merchant profile,” Paul Patterson, an analyst at Glenrock Associates, said.
To many investors, hybrid utilities that have both regulated and merchant operations send a mixed message. They combine the stable cash flow of a regulated utility with the volatility of merchant generation that is largely at the mercy of fluctuations in commodity prices, particularly natural gas prices.
If investors want exposure to both sectors they can invest in individual pure play regulated utilities and in the stocks of merchant generators, aka, independent power producers or IPPs like Dynegy or Calpine. And, if they want to fine tune their portfolio, they can adjust those individual holdings, Patterson said.
AEP’s rational for the sale fits well within that view. "AEP's long-term strategy has been to become a fully-regulated, premium energy company focused on investment in infrastructure and the energy innovations that our customers want and need,” Nicholas Akins, the company’s chairman, president and CEO, said in a statement announcing the acquisition. “This transaction advances that strategy and reduces some of the business risks associated with operating competitive generating assets."
In this case, however, the success of private equity in the bidding process was potentially affected by another factor.
In the regulatory debates involving granting power purchase agreements (PPAs) to some of AEP competitive, or merchant, power plants, the arguments became contentious. Media reports say that AEP excluded Dynegy and other IPPs from bidding for the four plants because the companies opposed AEP's efforts to win financial support for a separate set of beleaguered generators.
“We aren't going to comment on the bidders or process,” AEP spokeswoman Melissa McHenry said.
AEP's evolving portfolio
The sale of the four plants does not solve all of AEP’s concerns about owning merchant generation, though. In fact, the deal may prove to be the easier part of the company’s move away from merchant generation. The four plants, and particularly the larger gas plants, are all healthy operating assets and sell into the PJM Interconnection.
In a Sept. 14 report, UBS analyst Julien Dumoulin-Smith said most of the value is inthe Lawrenceburg and Waterford gas plants. He put the value of those two plants at about 8 times EV/EBITDA (enterprise value/earnings before interest, taxes, depreciation and amortization).
“Concerns over coal ash and future viability” likely depressed the implied multiple on the coal plant to about 5x EV/EBITDA or lower, Dumoulin-Smith said, pegging the consolidated value of the deal at about 7x EV/EBITDA.
Those values are reflected in the bidding. One market participant, who requested anonymity, said the winning bid was about 10% above some of the others and was possibly more aggressive in accepting some of the potential environmental liabilities.
For AEP, the sale price represents a fairly robust return based solely on construction and acquisition costs. AEP, through its Columbus Southern Power utility subsidiary, bought the Waterford plant from an affiliate of Public Service Enterprise Group (PSEG) for about $220 million in September 2005. It also bought the Lawrenceburg plant from PSEG, for $325 million in May 2007. And it bought the Darby plant from DPL Energy for $102 million in April 2007.
AEP completed construction of the Gavin coal plant in 1975 at a cost of $600 million. It is fully compliant with current environmental regulations, McHenry said. The combined acquisition/construction costs for the four plants is $1.24 billion.
But the other merchant plants in AEP’s portfolio may not fare as well if and when they come to market.
One is certain to come to market — a 48 MW Racine hydro plant in Ohio that McHenry said did not fit in the coal and gas plant package and will be sold in a separate process.
Other than that, AEP has its so-called PPA plants. Those plants have been the center of long-standing regulatory battles. The plants face challenges in the competitive market, so AEP has sought to preserve the value of their diversity and local benefits by seeking approval for PPAs that would allow them to continue to enjoy guaranteed, ratebased incomes.
AEP owns either full or partial stakes in the plants, which are all in Ohio. They are unit 1 of the Cardinal plant in Brilliant, units 4, 5 and 6 of the Conesville plant in Conesville, the Stuart plant in Aberdeen and the Zimmer plant in Moscow. In all, AEP’s net ownership comes to 2,677 MW.
AEP, along with FirstEnergy, which joined AEP in the filing, won Public Utilities Commission of Ohio (PUCO) approval for the PPAs in March, but in April the Federal Energy Regulatory Commission (FERC) blocked the PPAs, saying the waiver for an affiliate transaction would require further review.
AEP decided it did not want to wait for a FERC review to be completed, McHenry said, and, instead, is pursuing a dual track for those plants.
The company is working with the state legislature on an effort that would restructure the state’s power sector to allow AEP Ohio to own generating assets and put them in ratebase. As part of that deal, AEP Ohio would also agree to develop solar power projects in the state.
On a separate track, AEP has engaged Goldman Sachs to perform a strategic review of the plants.
If it comes to it, those plants could be a much harder sell, but if the past is prologue, they could end up owned by private equity.