Energy Futures Holdings (EFH) Revisited

Energy Futures Holdings (EFH) is a large utility based in Texas that used to be TXU. They were taken over by private equity in one of the largest buyouts during the “peak year” of 2007. I wrote about them here as they began to have problems repaying their monstrous pile of debt which mainly comes due in 2014. If you go to this file on EFH’s web site and go to page 12 you can see the $20B in debt coming due on that date (EFH is privately held and thus does not have a stock ticker but since their debt is publicly held they do have analyst presentations).

The New York Times wrote an article on the EFH buy out titled “Power Players, Unplugged” on February 28, 2010. While we may take the NY Times to task from time to time on politics in general I find their business writing to be of high quality.

They sum up the deal as so:

The buyout was, in effect, a gargantuan bet that natural gas prices would keep climbing; instead, plunging prices coupled with a hobbled national economy have cut into the cash the company generates.

Investors who bought $40B of TXU’s bonds and loands – including legendary wise men like Warren Buffett – have seen huge losses as most of the bonds trade between 70 and 80 cents on the dollars. The other $8B used to finance the buyout came from the private equity investors themselves… analysts say that this latter stake currently has little value.

This is fairly accurate. As I noted in many posts, the market clearing price for electricity is set by the price of natural gas. All of the nuclear plants run, and almost all of the coal plants run, but the price that they receive from the market depends on the marginal cost of power for the last plant turned on, which is typically a gas “peaking” plant. While the price for natural gas went as high as $14 / unit, it now trades around $4 / unit, due to the fact that huge volumes of new gas were found in the US and we also have the ability to import natural gas (LNG) from abroad. I write about the fall of natural gas prices here.

Gas prices typically spike up during the winter (it is a fuel primarily used for heating) and then fall during the summer, when utilities use this time to refill their storage with cheaper summer gas. If the winter is over and natural gas prices are around $4 / unit, this likely bodes for a further price cut this summer, when Texas gets hot again and EFH has to make up the bulk of their profits. If these prices stay low or go even lower, which seems likely, then EFH will see their margins cut significantly on their nuclear and coal generation, which will further compromise their ability to save money to pay off the huge pile of debt that comes due in 2014.

While the NY Times goes through the politics that EFH used to convince regulators and others in Texas to allow the utility to go private, they fail to hit on the most interesting part of the story – the fact that this is one of the few leveraged buy outs that I am aware of that didn’t bring any significant ideas to try to run their new quarry more efficiently. Basically their plan was to drop new investment in coal generation(TXU was going to build 11 coal plants, but when EFH went private they agreed to drop 8 of these and just complete the 3 that were in progress, which threw a “bone” to the green crowd)and then apparently hedge the price of natural gas and try to cover the huge debt burden with increased cash flows, I guess.

Anything can happen and perhaps EFH will be able to “force” creditors to roll over their debt positions into new debt with longer maturities and then they can just continue running the utility and hope that demand re-surges and the price of natural gas, too. This is basically a strategy of not investing in incremental generation (unlike TXU, which was betting big on cheap Texas coal) and hoping that rising gas prices allow them to make a fortune off their paid-for-by-ratepayers nuclear and older coal plants.

The NY Times gets it right with this final quote, about what is likely to happen to those that lent money to EFH:

But recent history suggests that when it comes to troubled megadeals of the golden age of private equity, debt investors often come up short. TXU is not likely to be an exception. In these deals, says Mr. Blaydon of Dartmouth, “the debtholders are going to get hosed”.

The equity holders have already been hosed, but since they are private equity kingpins, no need to shed a tear for them.

As far as the customers of EFH in Texas, it is hard to see what the value of this buy out was for them. Way back when this deal was first consummated in 2007 I wrote of an unholy alliance between the greens and the financiers which came to pass. If EFH stumbles and can’t refinance their debt the state will have to do something to keep this major entity solvent; they can’t allow it to just be seized by creditors and sold for parts. We will see how this story turns out.

Cross posted at LITGM

12 thoughts on “Energy Futures Holdings (EFH) Revisited”

  1. “in general I find their business writing to be of high quality.”

    Depends. Gretchen Morgenson, Floyd Norris, and (shudder) Louis Uchtiel are Democrat party hacks. Ignore them and you will be smarter.

  2. I would think gas at 4$/unit is competitive with coal in any location distant from mines,particularly in Europe where they have fallen for the AGW scam,which effectively increases coal prices,perhaps 20$/ton

  3. “If you had a thousand dollars to invest in a utility in the US which one would it be, and why?”

    British Petroleum (BP) (cue snare drum rim shot)

    My holdings in evil, atmosphere-destroying, oil-depleting oil companies have gone up. My holdings in windmill-building, nuke-plant contemplating NRG (electric power generator — yes, I have a “position” in it, but the P/E ratio is very low (attractive) although they have seen some earnings “erosion” since last year), well, NRG is the only stock I have that is down.

  4. On the East side of the state, South Texas Project 1 and 2 (large nuclear plants) sell their output to a power marketer at a fixed price. The power marketer then sells to electric utility distributers and large consumers. STP has long term contracts three years ahead.

    That raises the issue of counterparty risk with the power marketer. They either have long-term sales contracts themselves or must have financial resources to weather adverse price swings.

    In my opinion, EFH used their lignite plant megaprojects as a bargaining chip to clear the way for new nuclear units at Comanche Peak. It seemed to work.

    While there has been lots of talk about huge new supplies of domestic natural gas, current low prices are more a function of economic slowdown than expanded supply. I’m a bit skeptical of the recent PR campaign – looks more like political posturing re cap ‘n trade to me.

    I follow natural gas prices here:

    I agree that the big buy-outs in Texas were more than a little fishy. Especially when Texas Pacific walked away with, what?, $6 billion for a few months work.

  5. BTW, Dave Crane at NRG is one smart cookie! He’s got guts too. I liked the way he stood up to Exelon in their proposed takeover.

  6. Renminbi – coal runs around 30 MMBTU/ton, so on an energy basis, typical prices in the $40/ton range (of which $10 would be transport) in the US are well under the lowest gas prices of the last few years (around $2.80/MMBTU in Texas). Natural gas markets are very regional (in a global sense) – European gas prices were in the $9-11/MMBTU range last year, so $20/ton in carbon taxes won’t mean much.

  7. One can’t expect landed LNG prices to be much under $6/mmBTU if they want to cover project costs. Of course, prices under that are possible in the US but alternate markets like Europe are likely to outbid anything under $6, as Phwest noted.

  8. Basically their plan was to drop new investment in coal generation(TXU was going to build 11 coal plants, but when EFH went private they agreed to drop 8 of these and just complete the 3 that were in progress, which threw a “bone” to the green crowd)and then apparently hedge the price of natural gas and try to cover the huge debt burden with increased cash flows, I guess.

    So, basically its the greens fault? If they went ahead with the original coal plants instead of gas what would their finances look like?

    Frankly, I don’t see the point in trying to invest in an industry where (1) politicians set the prices and (2) politicians decide what technology you can use. How the hell do you plan for anything?

  9. Mr. Love,

    Your insight, (“Frankly, I don’t see the point in trying to invest in an industry where (1) politicians set the prices and (2) politicians decide what technology you can use. How the hell do you plan for anything?”) was the same diagnosis for the Great Depression.

  10. Utilities worked OK with problems when they were regulated. There wasn’t a lot of innovation but generally at least the utilities TRIED to plan for future growth including investments in transmission. The utilities DID care when service sucked because they’d get an earful from their regulators.

    The bad thing about this in Texas is that there isn’t that much more innovation and the utility is loaded to the gills with debt. This limits their room to survive extended periods of low prices and keep investing in their core franchise.

    As far as what to do with NEW investment, you are 100% correct in noting that capricious governmental policy erodes the ability to plan and invest. That is why many (most) of the big players are sitting out new generation and transmission investments and just utilizing their core (paid for) generation assets and throwing a few peakers into the mix.

    I wouldn’t make an investment recommendation on energy. There are a lot of variables. Exelon is a well run company in that they won’t over pay for an acquisition. Wayne Leonard is the smartest person in the industry, for what that’s worth. Crane at NRG has played his hand well but at some point he has to fold for a high price, it seems. EXXON is always the most diligent and best run company in the long term, but that doesn’t mean that they are a good investment, depends on pricing.

    Probably the foreign companies that can access energy in countries run by dictators where the US and Europe won’t touch would give you the highest returns, in the long term. If you don’t care about who gets killed along the way and whose pockets you are stuffing that should be a financial advantage.

  11. One downside of deregulation is the increased cost of capital required for new generation. If capital cost 10% under state regulation for cost of service, with certificates of convenience and necessity issued by the state regulator, the comparable cost for merchant generation could be 15%.

    Here’s my analysis from 2003:

    As to Exelon, it is the largest operator of nuclear power plants in the country but STP 1 and 2 have the highest total output and the best capacity factor and the highest ratings from government and industry groups. Those of us with experience working for various nuclear operators think Exelon is competent but difficult. STP Nuclear Operating Company (NRG’s operating arm at STP) are the best in the business though – on so many levels. (And that’s more than just my suckup too!)

    As to innovation – why? Our customers value above almost every other virtue reliablity. Price is important but as an engineer, there are NO game changing technologies now, tomorrow, or on the horizon. It is just physics. Certainly, minor improvements can be made and ARE BEING MADE, but they are invisible to the customer.

    The most dangerous innovation, to my mind, is the “smart grid.” Its real purpose is to change the business model from “serve the customer and meet his demand” to a model where the customers have to curtail their needs to conform to the political decisions of the regulators. The State of California wants to reduce electrical demand so will use the smart grid to setback thermostats and turn off applicances to avoid investment decisions that don’t conform to the reigning ideology of green house gases. So next heat wave (like the last), when it heats up and the wind stops, customers will just have to sweat. Of course, the state’s elites live near the Pacific Ocean where the cool water moderates the temperatures, not in the Central Valley.

Comments are closed.