Banking on power?

I found the news that Goldman Sachs is to buy stricken US developer Cogentrix Energy intriguing to say the least. After all, what business does a bank have owning power assets?

The $2.4 billion acquisition will add 26 generating plants and 3300 MW to Goldman’s generating portfolio taking it to a total of 27 plants and 4255 MW. Just prior to the Cogentrix deal, the bank completed the $1.06 billion purchase of El Paso’s stake in East Coast Power, the owner of a generating plant in New Jersey.

At first glance, a bank actively seeking to make power plant acquisitions seems a strange move. Is it not tough enough just lending money in a sector which has seen its fair share of financial woes over the last few years? What does a bank know about power plants? Where are the synergies? All valid questions. Yet if there is one certainty, it is that if a bank decides to do something, it is for money not love.

Certainly a bank could typically end up owning all of, or at least a stake in a plant by default. For example, this may soon be the case at Drax in the UK following the decision by AES to walk away from the plant. The creditors, made up of some 50 banks and bondholders, have been asked to vote on what stake they want to take up in the new company that will own the plant. AES Drax Holdings has entered into an exclusive arrangement with International Power (IP) which has offered to buy up to 34 per cent of the debt from the creditors.

But the purchase of Cogentrix is different. Such a proactive, planned move maybe seems to indicate that the US market is at the bottom of a downturn and that now is the time to buy assets. The simple view is that they see plant ownership as a way to make money. If you look at the UK market, there is the view that wholesale power prices are low but will rise over time. Equity investors will be looking at buying assets relatively cheaply at the bottom of the market and selling them in say five years time to make huge profits when prices pick up.

Alexander Alting, managing director and head of ING’s European utilities operation commented: “This is the type of thing you will see in the US, UK and to a lesser degree Australia. The power business has similarities to real estate in that, over time, it is quite a stable commodity which everybody needs. Therefore you cannot really go wrong, especially when investing at the bottom of a downturn. Now with the traditional plant owners not being in an acquisitive mood, there is an opportunity for private equity investors.”

If the investor can create synergies and leverage his assets it makes even more sense. Banks are no strangers to the business. Both Goldman Sachs and Morgan Stanley, for example, are already significant players in the electricity trading business.

Richard McMahon, Edison Electric Institute’s Executive Director, Alliance of Energy Suppliers commented: “When Enron collapsed and some of the utilities that had been in the merchant trading business exited, there was a need for someone to come in and provide liquidity. There will always be a need for a trading function. The trend is now that people with the physical assets are doing more of the trading.”

Speaking to the Financial Times on their power business strategy Doug Kimmelman, managing director in Goldman’s commodity group said: “We are focussed on a balance between our financial trading activity and asset ownership,” while John Shapiro, head of energy trading at Morgan Stanley, noted: “If we could do it purely in a financial way, we’d prefer to do that. But we see opportunities to buy physical assets that we can’t pass up.”

So has the US market bottomed out? McMahon sees the activity by the banks as a sign that the industry in the US is on the verge of a rebound. “Their participation is a good thing. They have come in, provided liquidity and proven that it’s a viable market by their presence. But I don’t know whether they are in it for the long haul when it comes to plant ownership.” I also have my doubts.

It may also be too much of an assumption that it may be a sign that the US market is coming out of a slump. A bank has never struck me as the type of institution to make an investment solely on the hope that it is in the right place at the right time. More often than not, there has to be a guaranteed return. And so we watch their moves with more than just a casual interest.

A Goldman executive was reported as saying that a significant share of Cogentrix’ value is in its contracts to supply power at regulated margins to various utilities. Most of Cogentrix’ plants fall under a federal law passed in 1978, under which utilities have to buy power from “qualifying facilities” under long term contracts at prices based on costs plus virtually assured profits. Kimmelman said: “The value is in the long-dated off-take contracts, not in the steel. We’re locking a very nice return.”

Being a bank, I bet you are.

Junior Isles, Managing Editor & Associate Publisher

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