| NEW YORK, June 8
NEW YORK, June 8 Texas faces the increased
possibility of power outages in the coming years unless new
plants are built, according to a report commissioned by the
Electric Reliability Council of Texas (ERCOT). The report
published June 1 by the Brattle Group contends improved economic
incentives are needed to ensure power reliability, potentially
benefitting the economic prospects of the state's largest power
producer Energy Future Holdings (fka TXU).
But, so far, TXU investor reaction to the report has been
Texas Competitive Electric Holdings Company's (TCEH)
$3.8 billion of bank debt due in October 2014 failed
to budge from currently depressed levels. Falling to 62 cents on
the dollar from the low 80s over the past year, the loan has
remained at those levels since last week. TCEH is Energy Future
Holdings' power generation subsidiary and the largest wholesale
electricity provider in ERCOT.
As well, neither the shape nor expensive pricing of TCEH's
credit default swap (CDS) curve changed much after the report's
release. The CDS curve spikes at two years and flattens beyond
three years, suggesting that TCEH is unlikely to successfully
manage its $29.8 billion debt load beyond that time frame.
Currently, investors would need to pay $6.55 million upfront and
$500,000 annually to protect $10 million of unsecured debt from
default for two years, while three- and four-year protection
contracts are respectively priced at $7.65 and $7.95 million
upfront for the same amount of protection and annual payments.
In a separate May report, ERCOT forecast reserve margins,
which measure excess power generation capacity during peak use,
to decline to 9.8 percent by 2014. This projection falls well
short of ERCOT's 13.75 percent target, which translates into a
one power outage event in 10 years.
Power demand has been primarily driven by a robust Texas
economy and 21 percent population growth over the last decade,
according to U.S. Census figures. Recent extreme weather has
further strained the power grid, enabling ERCOT to set several
new records for peak use in the past year.
But after adding close to 25,000 megawatts of new coal and
gas-fired plants over the last decade, power producers have
largely halted new plant construction due to volatile economics
and forward power prices currently insufficient to encourage new
Natural gas prices, which represent the marginal fuel
setting the price of power in ERCOT, have fallen to $2.45 mmBTU
from over $4.00 mmBTU last year. In addition, the forward gas
curve for the next two years does not project a return to last
Unlike other power markets, ERCOT does not offer capacity
payments to ensure generators are available for dispatch during
peak power usage. ERCOT's deregulated retail market also enables
customers to shop around, which discourages procurers of power
from entering into long-term power purchase agreements with
wholesale generators like TCEH.
Low revenue visibility then forces ERCOT power producers to
rely on difficult to predict factors, including natural gas
price swings and extreme weather, to drive economics.
To incentivize investment, Brattle Group discussed several
potential solutions that include introducing capacity payments
and raising caps on power prices from $3,000/MWh to $9,000/MWh
when the grid is stressed. A higher $4,500/MWh cap has already
been proposed for this summer by ERCOT.
"While a lot of positive steps to date have been taken to
incentivize new investment, more needs to be done," said Stephen
Byrd, senior utilities equity analyst at Morgan Stanley. "These
steps should be generally positive for asset values if ERCOT
wants to maintain their commitment to very high reliability."
Capital structure options
Aside from an in-court restructuring, TCEH has several
options to offer creditors willing to take a longer-term view on
market recovery and potential investment incentives from ERCOT.
In its latest investor presentation, the company disclosed $750
million of first-lien and $1.88 billion of second-lien capacity
that can be used to issue additional secured debt or execute
exchange offers with debt holders. There is a nominal $1.5
billion of investment basket that could provide additional
financing opportunities as well.
Investors have given TCEH some breathing room in the past.
In April 2011, bank debt lenders extended $15.4 billion of
maturities from 2014 to 2017 in return for higher coupon and
upfront fees among other concessions. Over the past three years,
Energy Future Holdings and TCEH have also reduced debt by
repurchasing or exchanging bonds at a discount.
Even if lenders do not give additional time for TCEH to fix
its balance sheet before the October 2014 maturity, one buyside
source argued that owning TCEH assets through a restructuring
still provides upside exposure to any increased economic
incentives from ERCOT. Another buyside investor added that the
Brattle report's policy recommendations are unlikely to
dramatically improve the company's credit profile in time.
"While few people are building new generation in ERCOT, TXU
has an untenable capital structure." said Bonnie Baha, head of
global developed credit at DoubleLine Capital which manages $35
billion in assets. "Those involved with TXU are mostly
distressed investors playing for recovery. The company is so
levered towards natural gas prices that unless you see a sharp
recovery, not much else can forestall a restructuring."