Many moons ago, when I was a kid, the local electric company owned everything from the giant turbines that generated electricity to the wires that lead to the fuse box in my house. The list of typical assets owned by the utility included the power generating plants, high voltage transmission lines, and the local distribution networks to individual customers. In exchange for this monopoly, utility rates were regulated by state governments. Not any more. With utility deregulation in the 1980s, utility assets were separated into distinctly separate businesses of electric generation and electric distribution. There is currently a subtle, but significant, shift in the ownership of electric power generation assets that may be of interest to utility investors.
In the wake of the catastrophic meltdown of Enron and the power trading industry, many energy companies are licking their wounds from untimely decisions to enter the power generation field. Just as companies were on a feeding frenzy of purchasing and trading electricity, there became an oversupply of electricity and power generation. In addition, a few companies ended up on the financial ropes, battered by trading losses, high debt incurred during generating plant acquisitions and soft product pricing. Power generating plants are being auctioned off again at bargain basement prices, but this time the buyers are not utility companies or utility-want-to-be’s, but rather Wall Street.
For starters, listed below are a few of the largest energy deals since Jan 2003, according to Platts Global Power Report:
Blackstone Group and Texas Pacific purchases most of Texas Genco for $14.1 billion,
Matlin Patterson Assets purchases power plants from Duke Energy for $5.1 billion,
GC Power Acquisition purchases remaining assets of Texas Genco for $3.65 billion,
Goldman Sachs purchases 26 power plants for $2.42 billion,
Texas Pacific purchases Portland General for $2.35 billion,
AIG purchases power generation assets from El Paso for $892 million,
Goldman Sachs purchases power plants and pipelines for $692 million.
There have been two kinds of buyers: investment banks eager to become players in the trading business and seeking generation plants to back up their trading positions; and private equity firms seeking undervalued investment bargains.
Wall Street has a history of taking more than a passing interest in the physical energy business. In the 1980’s, Wall Street bought, or had access to, distressed oil refineries and traded their production. Firms such as Saloman Brothers, Philbro and Transworld Oil bought refineries and hedged their production in the futures market. Wall Street could speculate in the oil markets, and had the ability to physically deliver the forward contracts of petroleum products if necessary. Over time, refinery asset prices increased and were divested at huge profits.
This time, financial institutions are buying undervalued electric power generation assets and are becoming more active in the energy trading business. Reminiscent of the 1980s refining strategy, Wall Street’ interest appears to be driven by low-priced energy assets and the ability to optimize profits by carefully melding their physical and financial trading approaches as they wait for a rebound in asset pricing.
In my opinion, theses firms stand to duplicate the huge profits made in the 1980s when the power generation asset markets improve in the future, most likely over the next three to five years.
Investors seeking undervalued investment opportunities may want to add companies in the power generation business to their research. Commodity prices are down, operating profits are down, assets values are down, and the market may be ripe for a long-term change of fortunes. Following Wall Street’s keen interest in the depressed power generation market may be an intriguing long-term individual investment strategy.
George C. Fisher is a 30-year veteran in DSP/DRIP investing. He is author of All About DRIPs and DSPs (McGraw Hill, 2001) and The StreetSmart Guide to Overlooked Stocks (McGraw Hill, 2002). Mr. Fisher is an avid dividend reinvestment advocate and utilizes the strategy with all dividend paying stocks, both at the broker and direct with the companies using their DRIP programs.