• Subscribe
  • Log In
  • Home
  • Daily Diary
  • Asset Class
    • U.S. Equity
    • Fixed Income
    • Global Equity
    • Commodities
    • Currencies
  • Sector
    • Basic Materials
    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financial Services
    • Healthcare
    • Industrials
    • Real Estate
    • Technology
    • Telecom Services
    • Transportation
    • Utilities
  • Latest
    • Articles
    • Video
    • Columnist Conversations
    • Best Ideas
    • Stock of the Day
  • Street Notes
  • Authors
    • Bruce Kamich
    • Doug Kass
    • Jim "Rev Shark" DePorre
    • Helene Meisler
    • Jonathan Heller
    • - See All -
  • Options
  • RMPIA
  • Switch Product
    • Action Alerts PLUS
    • Quant Ratings
    • Real Money
    • Real Money Pro
    • Retirement
    • Stocks Under $10
    • TheStreet
    • Top Stocks
    • Trifecta Stocks
  1. Home
  2. / Investing
  3. / Energy

Power Incumbents Rule

The lack of financing plus debt and equity ratios power established energy companies.
By GLENN WILLIAMS Feb 15, 2014 | 10:00 AM EST
Stocks quotes in this article: PCG, SRE, EIX, EXC, NRG, CPN, ETR

When it comes to financing new energy facilities, somebody has to take risk. It usually comes down to the developer or the consumer. If neither is willing, the project's plan is shelved.

Historically, most gas and electric projects were hedged against the state. Under this arrangement, state regulators guaranteed debt holders they would recover their loans and interest expense. Regulators also guaranteed equity holders revenues high enough to assure them a margin.

The art of project financing was optimizing the debt and equity ratio. If interests were low, states and utilities would seek higher debt levels and lower gross returns on equity. Depending on rates, most projects could justify 60% debt and 40% equity. Some sought higher ratios; up near 80% debt and 20% equity.

The state passed the project's risks on to their consumers through the state's system of tariffs. State-approved tariffs would require consumers to pay investors expected returns through utility rates. In the end, consumers assumed almost all financial risks to build natural gas pipelines, electric transmission lines, gas and electric distribution systems and power plants.

In fact, every commercial nuclear power plant built in the U.S. had government guarantees. The same is true with all utility-owned coal-fired power plants, oil-fired plants and most gas-fired power plants.

However, a decade ago, several states reconsidered their role as hedge managers. One by one, they decided the market was a better tool to manage certain gas and electric assets. Many of these states restructured their utilities. They unwound their hedges. They no longer guarantee returns for large energy projects.

With an important hedge gone, restructured utilities looked elsewhere to offset their market risks. Larger projects found few willing to assume market risks. In fact, most project developers could not find a single party willing to speculate on an obvious energy projects.  

There are short-term power purchase agreements available. Some grids offer capacity payments on a year-to-year basis. However, none of these arrangements will work for project financing, because the commitment is too short.

To attract low cost debt, projects need bankable third parties to hedge production for as long as any ratable debt remains in place. Most debt has terms of 20 or 30 years. Therefore, developers must find buyers willing to commit to buy power for 20 or 30 years.

In the private sector, those buyers are difficult to find. The only entity willing to take long-term risk positions are state governments. Most state governments are only interested in renewable energy.

The state of California has been one of the nation's largest sources of power purchase agreements. They reverted to the old model. California assumed the risk and transferred it to PG&E's (PCG) Pacific Gas and Electric utility, Sempra Energy's (SRE) San Diego Gas & Electric and Edison International's (EIX) Southern California Edison. In return, these utilities had state permission to pass on their costs to customers. In the end, the customers are assuming most of the risk.

At least 22 other states authorized power purchase arrangements directed at renewable energy (six states specifically disallow or restrict such agreements). Most of these agreements do not cover traditional power production.

This means many large and important projects are on the shelf. Most of these projects offer reliable sources of power. They are compliant and relatively clean. They are economic in the traditional sense. They provide a balance in the grid's merit order. They just cannot be financed.

Some may ask, why not shift the risk from the consumer to the developer?

Some have. There are small gas turbines and upradedes that have or will go forward. Two or three speculative large-scale gas turbine projects may go forward. In all likelihood, these projects will have their debt holders in firm control of the cash flows. However, these larger projects have yet to seriously commit.

The lack of financing and the magic of debt and equity ratios help Exelon (EXC), NRG Energy (NRG) and Calpine (CPN). It may even help Entergy (ETR). Project financing has become a barrier to competition. Existing fleets may be depleting, but they need not fear new entrants, particularly for base load.

In the end, something has to give. Some expect the power and natural gas markets will break, high prices will become norm and investors will rush in. Others believe market rules will have to change. In the meantime, and it could be a long time, incumbents' hands are becoming incrementally stronger.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication the author held no position in the stocks mentioned.

TAGS: Investing | U.S. Equity | Energy

More from Energy

The Market, It's Such a Gas!

Helene Meisler
Jul 1, 2022 6:00 AM EDT

Commodities like gas came down and people finally noticed. Let's check on that diesel, 30-year bonds and more.

Want to Save Your Retirement Fund? Tune Out the Talking Heads

Jim Collins
Jun 30, 2022 3:14 PM EDT

The first half of this year has been ugly. But we could have seen what would happen to Netflix, Tesla and Meta...

OPEC+ Opens the Spigot, but Are We Just Repeating Mistakes of 2008?

Maleeha Bengali
Jun 30, 2022 12:26 PM EDT

As we see this increase in oil production get rubberstamped, we must remember that demand never moves in a straight line.

Commodity Bull Runs Have Proven Unsustainable; Can This Time Be Different?

Carley Garner
Jun 30, 2022 12:00 PM EDT

It's possible, but unlikely, as we've yet to see the commodity complex hold gains forged in a bull market.

My Setup for the Second Half of 2022 Begins With These 13 Stock Picks

Stephen Guilfoyle
Jun 30, 2022 11:00 AM EDT

I'm setting up for the next six months with selections in Energy, Staples, Semiconductors, and Aerospace & Defense.

Real Money's message boards are strictly for the open exchange of investment ideas among registered users. Any discussions or subjects off that topic or that do not promote this goal will be removed at the discretion of the site's moderators. Abusive, insensitive or threatening comments will not be tolerated and will be deleted. Thank you for your cooperation. If you have questions, please contact us here.

Email

CANCEL
SUBMIT

Email sent

Thank you, your email to has been sent successfully.

DONE

Oops!

We're sorry. There was a problem trying to send your email to .
Please contact customer support to let us know.

DONE

Please Join or Log In to Email Our Authors.

Email Real Money's Wall Street Pros for further analysis and insight

Already a Subscriber? Login

Columnist Conversation

  • 07:59 PM EDT PAUL PRICE

    Very good quarterly numbers from Bassett Furniture (BSET)

    Bassett Furniture (BSET) blew right through analys...
  • 04:41 PM EDT PAUL PRICE

    First Half Results - Putrid Second Half Results - Likely to Be Much Better

    It's great that we're done with June. 2022 marked...
  • 04:51 PM EDT PAUL PRICE

    We Should Be in for Better Starting Soon

    Window dressing Thursday, the last day of the...
  • See More

COLUMNIST TWEETS

  • A Twitter List by realmoney
About Privacy Terms of Use

© 1996-2022 TheStreet, Inc., 225 Liberty Street, 27th Floor, New York, NY 10281

Need Help? Contact Customer Service

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data & Company fundamental data provided by FactSet. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by FactSet Digital Solutions Group.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

FactSet calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.

Compare Brokers

Please Join or Log In to manage and receive alerts.

Follow Real Money's Wall Street Pros to receive real-time investing alerts

Already a Subscriber? Login