Consolidation has only just begun in the US power markets as the sector combines for greater regional and financial heft ahead of potentially-transformative regulatory changes.
There have been 51 deals announced in 2011 to date against the background of 242 deals in the broader energy and mining sector, according to Mergermarket’s Amanda Levin, speaking at the Platts Financing US Power conference in New York.
“US utilities are still relatively small compared to their counterparts abroad,” JP Morgan Securities Managing Director Jay Horine said.
While early deal activity has focused on the regulated utility sector, where cash flows are more reliable and exposure to volatile power markets is muted, the wave of consolidation activity is likely to continue into the merchant generation sector as well. Mergers and acquisitions activity remains constrained by sharp regional differences in power regulation and market design, meaning that for now many of the opportunities for dealmakers are local and specific.
“Power markets are no different than real estate; it’s all about location, location, location,” Quantum Utility Generation CFO Sean O’Donnell said at the conference.
“One of the biggest contributors to preventing companies from stepping out their existing regulatory footprint” is the patchwork of regulations across the country, O’Donnell said.
“Power plants are very local when it comes to valuation,” JP Morgan’s Horine agreed.
The panel of bankers and analysts expressed mystification at the high level of valuations in the power sector for individual assets, and said that the high prices, although limiting deals to date, could start to attract sellers. Prices for power plants remain at 2006 levels even as power prices have fallen sharply on a national basis since then and usage rates are near 40-year lows.
“More foreign companies are looking at their US assets and deciding that opportunities are better elsewhere,” Levin said, and that has prompted talk of sales.
To date US firms have only become buyers of individual plants when they can put the new asset in their rate base or need the additional generating capacity to satisfy growing load demand, Horine said. With average national reserve margins of 22.5%, the number of constrained generators seeking further new capacity to meet demand remains small.
Renewables Show Range
A rare bright spot in the business of selling and buying individual power generation assets has been renewable generation, particularly wind and solar projects. Projects in those sectors are using comparatively sophisticated joint ventures with larger utilities to satisfy state and regional requirements on use of renewable generation. Joint ventures are rare in the “conventional fuels” sector, O’Donnell said, where utilities prefer to own their power plants outright.
“There is a desire to hold on to the assets,” JP Morgan’s Horine said, with protection of a firm’s credit rating at the bottom of the business cycle a higher priority than opportunistic dealmaking.
The involvement of traditional investor-owned utilities in those renewable JVs is part of a broader trend of increased sophistication on the part of utility executives overall, Horine said. The trend of chief financial officers rising into CEO positions and replacing the traditional role of former chief legal officers in heading companies has resulted in a “material” change in financial acumen at power companies, Horine said, and an openness to new kinds of financing and ownership structures.