Wholesale power: bankruptcies and lessons
Energy Future Holdings (EFH), the massive Texas electric holding company, formally warned last week that it might need to seek bankruptcy protection. A little more than five years ago EFH was created as the vehicle for the most expensive leveraged buy-out in history when a private equity group led by KKR, TPG and Goldman Sachs bought the Texas energy company at a price of $43.2 billion.
Questions of the company's survival have circulated for years as doubts have grown over EFH's ability to meet obligations on more than $38 billion in debt.
Is this just another narrative about how the fracking revolution, and the associated collapse in natural gas prices, is reshaping America's energy landscape?
The answer is that and more. While the foundation for this story is the huge miss by the buyers on a bet about future natural gas prices, the whole story is complex and evolving, with fascinating historical context - the implications will be far reaching.
Summaries can be found here and here , and I'll be spending some more time on this in my Energy Trends Insider column Banking Energy in the coming weeks, but here are some broad implications that will begin to take hold and effect the industry over the coming months:
* Wholesale power remains a tough business. A string of bankruptcies and restructurings defines the short history of the independent power business, and with EFH on the brink and Edison International's Edison Mission Energy already under bankruptcy protection the challenging legacy of the wholesale power business will only grow.
* KKR, TPG and their investors are going to lose money, quite a bit of it. KKR has already written down the value of its direct stake (separate from managed funds) by 95%. Bondholders may take similar valuation hits; Warren Buffet called his investment in EFH bonds "a major unforced error" and has already written values down significantly. With the potential for some loss to even senior secured debt it seems likely that the cost of financing wholesale power is going up.
* Financing new coal generating capacity in the current climate in the U.S. looks like an extremely difficult prospect. In addition to overarching regulatory uncertainty, the EFH story is going to have an impact. EFH spent billions to build 3 new coal power plants in 2009 and 2010, and more than 2/3 of actual electric generation in 2012 was from coal. Regardless of the reality of the underlying economics, the EFH failure only adds to a souring narrative on the value of coal plants in the U.S. market.
* Bankruptcy will test the Texas Public Utility Commission's ability to protect ratepayers from the costs of the failed buy-out. Both the PUC and Oncor have expressed certainty that the "ring-fence" put in place to isolate Oncor from the financial risks of the deal is impenetrable, but an EFH financing arm has been leveraging Oncor intercompany dividends to pay down intercompany debt. The ring-fence will certainly be tested in Federal Bankruptcy Court.
* Regardless of the outcome over the Oncor ring-fence challenge, look for regulators to press even harder to limit deals that might put a utility and its ratepayers at risk - and this resistance will compound the tension in the evolving reality for utilities of eroding electricity demand and increasing need for investment to replace and upgrade aging or vulnerable infrastructure.
Expect to hear a lot more about this story as EFH inches closer to bankruptcy - this may be the energy story that defines 2013.
– This article originally appeared in Energy Trends Report, a free subscriber-only newsletter that identifies and analyzes financial trends in the energy sector. It's published by Energy Trends Insider.
