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The Mad, Mad World of Merchant Power

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It's been a wild dozen or so years for the broken-apart utilities, but an even wilder period for the merchants.

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In the late 1990s, the brilliant idea emerged of breaking apart electric utilities to spur competition.

For the most part, electric utilities were local or regional monopolies comprised of a batch of power generation facilities that sold electricity to their captive residential and commercial customers over their transmission and distribution lines.

The idea for the power sector that stemmed from the deregulation movement under Ronald Reagan was to hive off the generation portion of the utilities and let new, so-called merchant generators be set up by anyone who wanted to build new facilities and sell into a wholesale power market. New retail companies would compete with each other for customers and buy the wholesale power. The wires would essentially be left alone.

It's been a wild dozen or so years for the broken-apart utilities, but an even wilder period for the merchants. I use the word "wilder" in the latter case as a substitute for the word "disastrous."

I say that for this reason: On Sunday, NRG Energy (NRG) and GenOn (GEN), two merchants, announced they were merging. And as one who has covered both companies for some time, I couldn't stop thinking what they both have been through ever since Enron collapsed.

First, the merger of two merchant firms comes at a time when many in the industry are listening with fascination to the testimony being given the North Carolina Utilities Commission on how, and why, the Duke Energy (DUK) board tried to get out of its merger with Progress Energy (PRQNF). These are not two merchant firms, but two utilities that own other utilities, and to hear how Duke's board waited until the day the merger with Progress was in effect before it fired its new CEO who was from Progress, left lots of people wondering, "what the hell?"

The NRG/GenOn deal also takes place as one of the original merchant firms, Dynegy (DYNIQ), seeks to exit bankruptcy. NRG was founded as the merchant arm of Xcel Energy (XEL) and went through its own bankruptcy in 2004.

Many of the original merchants, such as PG&E (PCG), then part of NEG (NEGI), which was liquidated in a Chapter 7 bankruptcy in 2004, ran into serious debt problems after borrowing heavily to build large amounts of natural gas-fired capacity.

For example,the purest merchant, Calpine (CPN), which owns just over 27,000 MW of natural gas-fired capacity, went into bankruptcy in 2005 after natural gas prices soared to over $12/MMBtu. Calpine is now out of bankruptcy, and suffering not from high gas prices but rather very lower power prices.

And in October 2005, NRG -- once out of bankruptcy -- bought Texas Genco which gave it Genco's 14,000 MW, including the 2,600 MW South Texas nuclear facility, for $5.8 billion. Funds for that deal came from a private equity consortium made up of The Blackstone Group (BX), Hellman & Friedman, Kohlberg Kravis Roberts (KKR) and the Texas Pacific Group.

Texas Genco was the group of generation assets in the Houston area that were spun off from the utility Houston Industries, later renamed Reliant Energy, when the Texas market was deregulated in 1999.

NRG not only bought the generating assets, but in March 2009 it bought Reliant Energy's retail electricity unit for the modest sum of $285 million. Reliant Energy had no generation, and it had lost its credit support when Merrill Lynch was folded into Bank of America (BAC).

So through its merger with GenOn, NRG goes almost full circle with former Reliant assets. Think of the mercurial character in the Terminator 2 movie whose liquidized "Cyborg" falls to the ground in pieces when blasted apart, only to slowly coagulate back into its former form.

GenOn was created after Mirant, the former merchant arm of Southern Company (SO), exited from bankruptcy and decided to merge with RRI Energy, the former merchant arm of Reliant Energy, in a $1.6 billion all-stock deal. RRI was the merchant firm Orion (OESX) that was created by Goldman Sachs (GS) and Constellation (CEP) that was bought by Reliant in October 2002 for almost $6 billion in borrowed money. Reliant spent two years trying to restructure that debt, and lost out on the chance to buy back its Texas Genco assets when its bankers, led by Goldman, ruled it out.

Mirant, of course, would come out of bankruptcy and take its own shot at buying NRG. In May 2006, Mirant launched an unsolicited $7.8 billion bid for the company, which was halted less than two months later when a hedge fund, owning just 1.6% of the shares, said Mirant should put itself on the auction block instead.

Meanwhile, in late 2008 and into July 2009, Exelon (EXC) made its own failed $7.5 billion attempt to buy NRG, which NRG's CEO David Crane consistently and successfully fought off.

Then in August 2009, Dynegy and privately held merchant LS Power undid a merger they had done in 2007. A year later, The Blackstone Group sought to buy Dynegy and sell off some of its generating assets to NRG to help pay for the deal.

Blackstone eventually withdrew its $4.7 billion offer when Dynegy shareholders, led by billionaire investor Carl Icahn, pressed for a higher price. Suffering from low power prices, reduced revenue and relatively high debt, Dynegy eventually did what all good merchants have done: File for bankruptcy.

This article originally appeared on Platts' The Barrel.
No positions in stocks mentioned.
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