Dynegy Deals Could Change the Game

 | Aug 22, 2014 | 3:00 PM EDT
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This morning, Dynegy (DYN) announced plans to acquire significant generating assets from two sellers: Duke Energy (DUK) and Energy Capital Partners.

Sold From Duke

Duke, which sold 11 fossil-fueled power plants for more than the company expected, certainly comes out a winner. Another winner, however, could be Dynegy.

Duke wants out of the merchant energy business. The company's new business strategy prefers regulated assets to market-facing assets. Months ago, Duke signaled its intention to sell its merchant fleet. This strategy helps the company to become a regulated-asset-only business.

Duke sold 11 merchant power plants with a capacity of approximately 6,100 megawatts for $2.8 billion. The sales price equates to approximately $460,000 per megawatt. This is an order of magnitude below replacement costs for combined cycle and coal assets. As such, it is a bargain for Dynegy.

It is also a bargain for Duke, which expected much less. Consequently, Duke will recognize a $500 million pre-tax reversal of the $1.4 billion impairment that the company previously booked in 2014.

All plants sold by Duke are dispatched into PJM Interconnection's wholesale power market. For reasons requiring much more discussion, the PJM location could become great news for Dynegy. In addition, all coal units are equipped with compliant environmental controls.

Here are some specifics:

  • Nine generators are located in Ohio.
  • One is in Illinois.
  • One is in Pennsylvania.
  • Four (approximately 3,120 megawatts) are efficient combined cycle gas turbines.
  • Five (approximately 2,660 megawatts) are complaint coal. The capacity represents Duke's interests because the coal plants are jointly owned with The AES Corporation (AES) and American Electric Power (AEP). AES and AEP ownership interests are not included in the transaction.
  • Two (approximately 2,502 megawatts) are gas turbines, which are used for peaking purposes.

At $460,000 a megawatt, all of these units could break even without selling any energy. PJM is one of the few regional transmission organizations with a mature capacity auction. PJM's capacity payments could cover Dynegy's capital expenses and more.

Sold From Energy Capital Partners

Energy Capital Partners is a private equity firm focused on energy infrastructure. The firm owns power plants of all types, midstream oil and gas, electric transmission, environmental infrastructure and related assets.

Energy Capital is selling two major assets for $3.45 billion. One is a 1,557-megawatt Brayton Point facility located in southern Massachusetts. The other is a 5,500-megawatt fleet of coal and natural gas power assets owned by Energy Capital's EquiPower Resources subsidiary.

Brayton Point is a 50-year-old coal plant that has been upgraded to become an efficient generator. The station has over $1.28 billion of environmental controls that reduce emissions by over 90%. It has reduced water usage and reduced heat discharge, and it recycles 100% of its ash. It exceeds all existing federal and state environmental requirements. While Energy Capital previously announced plans to retire Brayton Point in 2013, it is a critical asset for New England's energy and capacity markets.

Approximately half of Energy Capital's assets (3,652-megawatts) are located in PJM. Like the Duke purchase, none of these assets will need to produce much power to break even. Two of these units are large gas turbines (1,976-megawatts), one is coal (1,093-megawatts) and one is an efficient combined cycle gas turbine (583-megawatts).

Approximately half of Energy Capital's assets (3,367-megawatts) operate in New England. Other than Brayton Point, all New England assets are efficient combined-cycle gas turbines. New England desperately needs power plant capacity but is generally unwilling to pay prices offered by PJM.

Approximately 60% of the assets sold by Energy Capital are being flipped. The firm purchased three of its larger facilities from Dominion Resources (D) just 12 months ago.

The price paid to Energy Capital equates to approximately $492,000 per megawatt. Again, this is an order of magnitude below replacement costs. It is a bargain for Dynegy, but not as solid as its buy from Duke. The difference is New England's capacity market, which is an economic challenge for all generators.

 Left at the Altar?

It appears that some assets have been left behind. Based on the company's announcement, it seems as though Duke was unable to sell its 1,100-megawatt interest in the Beckjord Station located in Ohio and that PJM, AES and AEP own the remaining capacity. Nevertheless, if Duke writes off all of its interest in this asset, the company is still far ahead.

AES may not be so lucky. A recent conference call suggested that AES was interested in selling merchant plants. This includes AES's interests in plants co-owned with Duke and AEP.

Consequently, Duke, AES and AEP may be working a deal to unload more capacity.

Move over NRG Energy (NRG); it appears as though Dynegy is emerging as a serious independent power producer. The company's new portfolio of generating assets is potentially strategic and profitable. If Dynegy's debt service is managed, this acquisition may help it move into a cost leadership position among fossil-fueled generators.

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