Falling electricity prices are taking a toll on Reliant Resources Inc.’s ambitious development program, but haven’t weakened the Houston firm’s belief acquiring Orion Power Holdings Inc. was a sound decision.
Joe Bob Perkins, executive vice-president and architect of the company’s wholesale strategy, said Reliant will complete all projects in construction and scale development prospects “way back.” Near-term prices are a lot lower than anyone expected them to be, he said.
But power prices further out, or the “far forwards,” are in line with expectations. That’s why Perkins says the economics for Reliant’s $2.9 billion acquisition of independent power producer Orion Power and ongoing construction still make sense, despite tightening capital markets, slumping forward power prices, a national recession, declining stock prices, and the recent meltdown of Enron Corp., the largest energy marketer and trader in the US.
Reliant Resources Tuesday said it had withdrawn and will refile its notification report required in connection with its acquisition of Orion.
The company said it will refile the report Wednesday, as part of a procedural step to provide the Department of Justice with more time to review the transaction. Reliant said it and Orion continue to believe the transaction will close early next year.
Financial analysts initially questioned how Reliant planned to fund such a large acquisition, in the face of an economic recession and wary capital markets still reeling from the telecommunications industry’s fall from grace.
When the deal was announced Sept. 27, a confident Perkins said Reliant did not need to issue stock to make the purchase. He noted Reliant Resources, a majority-owned affiliate of Reliant Energy Inc., enjoyed the confidence of its banks, had factored in slumping forward power prices, and had a healthy balance sheet.
“The ratings agencies and the banks are comfortable with us,” he said.
Indeed, Reliant Resources reported on Nov. 16 that a consortium of banks committed $2.2 billion in unsecured credit to fund the Orion acquisition. Banks extended $400 million more credit than Reliant requested because of “robust demand,” the company said. The balance of the purchase will come from cash on hand and an existing bank credit line.
The Orion purchase, while huge, is not expected to be Reliant’s last US acquisition. Poor economic conditions will create buying opportunities, Perkins said. “The industry is very fragmented and there is room for consolidation,” he said. “Consolidation is the rational way of organizing the industry in times of crisis.”
In contrast to a controversial asset-light approach once touted by Enron as the industry’s future, Reliant has pursued an asset based strategy. The company has put some European assets on the block, but, meanwhile, is strengthening its position as the second largest power generator in the US. Reliant has 20,000 Mw in operation, under construction, or under contract in the US.
The Orion purchase will give the company an additional 5,926 Mw in operation and 5,000 Mw under construction and in development. (These figures exclude generation owned by its majority stakeholder, Reliant Energy, which has 14,040 Mw of regulated generation. Reliant Resources has the first right to purchase that generation in 2004.)
“In today’s capital market a pure trading strategy without assets is not sustainable,” said Perkins. “Pure asset light strategy won’t work.”
Fallout from unnerving disclosures by Enron about a series of off-balance sheet, related-party transactions have reverberated throughout the industry and the capital markets. “Enron reduced confidence in the sector,” said Perkins.
Now any off-balance-sheet transaction is heavily scrutinized, he said. One of the reasons banks are comfortable with Reliant is because of its financial disclosure policy, Perkins said. “We are so careful with disclosure. We write everything, including the kitchen sink,” he said.
Like many in the industry, Reliant has used off-balance-sheet transactions, but they are not tied to the company’s equity and are backed by hard power assets in the US. Perkins said the danger signs are equity-leveraged transactions backed by nonperforming or questionable assets. “We don’t have that and never did,” he said.
On the other hand, Perkins conceded Enron’s problems have created wholesale market and trading opportunities for Reliant to diversify its mostly short and medium-term power and gas portfolio to include long-term deals.
Enron made a market in long-term deals, but customers are wary about signing new long-term contracts, Enron executives said on a recent conference call. “We are in a position to offer that (long-term) product,” Perkins said.
Volatility and deregulation
Repercussions from the unchecked volatility in electricity prices in California and other parts of the West in the summer of 2002 hurt deregulation of the retail markets. Perkins said there won’t be a “big bang” in the evolution of the power markets now. He thinks markets will take more time to become completely competitive.
Commodity markets will be volatile, but Perkins downplayed events in California as a “100-year flood event” of electricity. He said that kind of volatility won’t happen again. Perkins blamed the unprecedented run up in prices on structural problems in the market, shortages of hydroelectric power, and robust electricity demand.
“Volatility will be with us. No one can control the weather and there is no storage of electricity,” he said. Under the regulated, vertically-integrated utility system, state regulators helped utilities spread volatility over several years, he said. But Perkins said it is more efficient for wholesale marketers and traders to manage that volatility for utilities that deliver power.
“Markets work better than Communist 7-year plans,” he said. Perkins predicted wholesale markets will be first to deregulate and larger industrial customers will be the first to participate. Later small residential customers will participate, too.
“The regulated aggregator, or the utility, can benefit from the competition in generation and the logistics of moving around power and using the lowest cost fuel and plants,” he said. Speeding the creation of large regional transmission organizations (RTOs) can only help the evolution of the competitive wholesale market, Perkins said.
Wholesale competition requires open access to the transmission system. Perkins said open access will help move the market towards competition and drive down costs. “The faster we get open access and consistent sets of rules and standards, the better,” he said.
Contact Ann de Rouffignac at firstname.lastname@example.org