Mergers and acquisitions in the utilities sector picked up in the first quarter as companies have begun to jettison merchant plants, according to PricewaterhouseCoopers US power and utilities deals leader Jeremy Fago.
PwC reported that first-quarter deal value in the utilities sector rose by 33% over the same period a year ago. This was driven in part by company efforts to sell off unregulated assets, according to Fago.
Regulated power plants are built and operated by regulated utilities, with rates negotiated between the utility and relevant State Utility Commission, and set at levels designed to fund the plant’s maintenance and operating costs, plus a return. Unregulated – or merchant – power plants, on the other hand, sell power into the competitive market, with no guaranteed return.
Low natural gas prices have put pressure on merchant power earnings, Fago told Breaking Energy. “Last year folks were seeing natural gas prices, particularly on the unregulated side, down at a level we hadn’t seen for a long time,” he said. Henry Hub spot prices traded below $2 per million Btu (MMBtu) for several days in April 2012, and below $3/MMBtu for most of the year, according to Energy Information Administration data.
While low natural gas prices mean lower feedstock costs for gas-fired plants, they also depress the market clearing price for power in unregulated markets. And that translates into lower margins – the difference between production costs and the market clearing price – for unregulated plants across the board, be they gas, coal or nuclear.
Many companies held on to their unregulated assets for most of last year, Fago said. “Given the low interest rate environment, folks were kind of holding on and evaluating particularly their merchant portfolios.” But he noted that the combination of sustained low gas prices and uncertainty surrounding impending environmental regulations has prompted some owners of unregulated assets to reconsider.
“You’ve got a lot of capital that needs to be spent on either retrofitting or mass compliance on the environmental side, or the decision to shut down a coal facility depending on whether the capital requirements make sense on a combined cycle [gas] plant,” Fago said. “We’re starting to see folks with both regulated and non-regulated businesses starting to reevaluate non-regulated assets.”
Hybrids – companies that hold both regulated and unregulated assets – may view the unregulated side of the business as a drain on capital that could be better deployed. “Particularly hybrids are looking at that and seeing two completely different business models,” said Fago. “We’ve got a non-regulated environment that’s proven to be somewhat volatile particularly with power prices falling off precipitously over the last few years,” he said.
“If you’re able to redeploy capital focus more on your regulated business, right now we’re seeing more and more people look at that,” Fago said
