Ken Silverstein EnergyBiz Insider Editor-in-Chief

Calpine hung on a lot longer than some of its contemporaries. Restructuring of the electricity industry in the 1990s along with surging demand necessitated the construction of more power plants and particularly ones built to run on natural gas. But, the industry overbuilt and power prices subsequently fell and squeezed the merchant energy sector. Calpine saw its stock hit a record high of $57 a share in April 2001. This week at the height of bankruptcy rumors, however, the company's stock has been delisted from the New York Stock Exchange.

Because forecasts made in the 1990s as to the future demand for power did not hold true, many lenders overvalued the energy assets used as collateral for the loans they made. That allowed unregulated independent power producers to borrow aggressively. The total merchant debt is $65 billion, due by 2012. While money is cheap today, the credit markets now give all their risks more scrutiny. There is little capital recovery because the spark spreads -- the difference between the prices of natural gas as a feedstock and the market price for electricity -- is so low.

To reduce its $18 billion debt, Calpine sold some of its 92 power plants as well as some natural gas reserves. While it sought to shed $3 billion, it has been successful at cutting $1 billion. Needless-to-say, the company needs to cut more -- and the firing of Cartwright and Kelly will only accelerate that. In the meantime, though, Fitch Ratings lowered its ratings on the company, noting that a Delaware Court said Calpine violated a loan covenant and that it needs to give $313 million of proceeds from an asset sale to bondholders.

The departure of the CEO and CFO is a precursor of things to come, Fitch says. Calpine "will pursue more aggressive restructuring measures in the near-term. Fitch cut its rating on Calpine's senior unsecured debt one notch to "CC," 10 levels below investment grade and an extremely speculative ranking, from "CCC-minus." The outlook is negative.

Many thought Calpine above the fray. Such merchants as Mirant and NRG that sell power on the open market struggled. Mirant is still in bankruptcy while NRG has emerged from Chapter 11. But Calpine has held on. It has even continued building power plants. Consider its Metcalf and Pastoria plants: They cost more than $1 billion but have yet to win the long-term contracts to cover their costs. The good news is that demand nationally for power is picking up.

Room for Optimism

The pressure on energy companies generally has been and remains intense: close to 200 were put on "credit watch negative" in 2002 alone. According to Standard & Poor's, downgrades in the merchant generation and trading sectors have slowed down as of year-end 2004 but at the same time, they have outpaced upgrades. The unregulated merchant business model has not changed much and no blueprint has yet to emerge to make those power sales and trades any less risky.

At the same time, recent projects undertaken by merchants remain exposed. Prior to construction, such companies received commitments for only 40-65 percent of the gas-fired power they were to generate. The idea was that the balance would be sold on the spot market for presumably more money than term deals -- a model that fell apart as natural gas prices soared and as wholesale electricity prices plummeted because of soft demand and too much generation supply. Basically, the spark spread is so thin that some companies have trouble covering their fixed costs.

There is room for optimism for the merchant sector generally and for Calpine. Fitch Ratings has a more optimistic take on the utility industry. After the "credit inferno" in 2002, it says "broad signs" exist that both the regulated and unregulated sectors are improving. In its 2005 projections, the credit agency says the near-term outlook for investor-owned electric utilities and affiliated generating companies is "stable" in 2005 while the outlook for diversified energy merchants "has shifted to positive from stable."

The better outlook for the merchant sector furthermore "reflects successful re-financings in 2004 that enabled most of these companies to extend debt maturities and eliminate near-term liquidity concerns," the Fitch report says. It credits low interest rates and accessible capital with improving liquidity and balance sheets. Such market dynamics were particularly helpful to the merchant utilities, which should see "continued opportunities."

Clearly, Calpine owns valuable assets, accounting for nearly 40 percent of all megawatts that will eventually be produced just in California where it is based, say regulators there.

And its management is intent on improving productivity and cutting expenses in an effort to lift its junk bond status. Like all merchants, it is staggering debt maturities, negotiating bank loan covenants and maintaining bank lines of credit in excess of anticipated needs.

And one need only look at NRG: It has restructured and produced robust returns. NRG has an advantage, however, because 75 percent of its generation fleet is fired by coal -- a far cheaper alternative than natural gas right now.

While the merchant sector is somewhat up, Calpine is down. That could change. Money is cheap, although borrowing conditions are stringent. The credit agencies say the overall goal is to get to a 50-50 debt-to-equity ratio, if companies want to achieve investment grade ratings. The companies able to do so will live on. Those that don't may sell out to those that are financially stronger.

For far more extensive news on the energy/power visit:  http://www.energycentral.com .

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