US Capacity Overhang Shifts Balance in Global Power Market

Global Finance, Dec 2003 by Green, Paula L

ELECTRIC POWER

The global electric power industry is undergoing some sharp changes as the focus switches from developed to emerging markets.

If you make your living from the electric power industry, the good news is that worldwide demand over the next three decades is expected to require nearly $10 trillion of investment from private and public sources. The bad news is that it's an extremely risky business in which to sink your money.

Subject to government regulatory whims in both developing and industrialized countries, overbuilding, nationalism, poor planning and low returns, the electric power business is volatile-even for experienced players.

And the harsh market conditions and global economic downturn of the past few years have left many power companies and their investors saddled with weak financial results while their unsatisfied bankers remain leery of making new deals. Some investors are even now literally holding the keys to generating plants that they once thought would be lucrative investments.

"The international power finance market has dried up," says Rick Vidal, associate director at Cambridge Energy Research Associates, a global consulting firm based in Cambridge, Massachusetts. "In a way, the banks are spooked. It started with the Asian financial crisis in 1997 and then moved over to North America."

Adds John McConomy, a partner in the Philadelphia office of the energy and utilities team at Pricewaterhouse-Coopers: "Project finance is pretty quiet right now. There's not a lot of lending going on.There's been a loss of liquidity and a reduction in credit quality."

Capacity Hangover

Perhaps the geographic region with the most unexpectedly disappointing results for investors and bankers in recent years has been the energy-guzzling market of the United States. Huge and hungry for electricity, the US electric power market has become overbuilt in the past few years as the promise of deregulation drew new players and the construction of too many plants. So-called merchant suppliers, who sell their electricity to whatever buyer needs the power, helped saturate the US market with their presence as deregulation took hold over the past decade.

In the past four years, 200,000 megawatts of new generating capacity has been added in the continental United States. And a 1,000-megawatt coal-powered power plant can cost $1 billion."Too much capital was invested in new generation capacity over the last three to four years," says Robert Petrosino, who is a director and senior utility analyst in the New York office of Barclays Capital, the investment banking division of Barclays Bank. Industry observers estimate that the US market will need anywhere from three to 10 years to recover from the capacity hangover.

Lenders have also been put on edge by energy company financial disasters, such as Enron, that emanated from corporate mischief.They've been rattled further by the subsequent US legislation-the Sarbanes-Oxley Act-that makes public companies more financially accountable.

And as the nightmare that California businesses and consumers experienced in 2001-complete with sky-rocketing prices and power outages-reined in the pace of deregulation, it also ended up clouding the regulatory framework in the United States. While Congressional committees have made progress on a national energy bill, versions of which have been kicking around for years, the United States still contains a patchwork of state regulations.The result is more uncertainty for power companies and their lenders and investors-which isn't good for the industry's financing prospects.

McConomy doesn't expect the US electric power sector to experience real growth until the US government lays out its intentions in new energy legislation.

"There's a lack of clarity around government regulations," he says. "Investors have to be confident that they will get a return on their investments." And that hasn't been happening. "The cost of fuel is high and the cost of power is low," says Jennifer Kreischler, another partner in the Philadelphia office of PricewaterhouseCoopers' energy and utilities team.

In the meantime, US bankers for the most part are contenting themselves with refinancing arrangements to help their clients take advantage of lower interest rates and restructuring deals, especially as the financially troubled merchant energy companies attempt to take out bridge loans and intermediate term-financing to get themselves through the tough financial times.

"There will be capital for the right deals. But the market will be focused on restructuring deals" says Chris Bealc, managing director and global head of project finance at Citigroup in NewYork.

Old Markets, New Opportunities

The immediate outlook for the electric power sector in Western and Eastern Europe is a bit more dynamic. Although the electric power industry technically has a capacity surplus, the continent has many plants more than 40 years old that will need to be replaced or refurbished over the next five years, Vidal says.