Ken Silverstein EnergyBiz Insider Editor-in-Chief

After some painful times, utilities have watched their spending and created new efficiencies. The real question is whether the glut that was created from overly aggressive expansion plans has been burned off or whether excess capacity still exists. Under any circumstance, the long-term expectation is that the population will grow and the need for cheap and abundant electricity will expand along with it. As the economy improves, credit will ease and investor confidence will return. At that point, construction can begin anew, particularly as older plants start to be retired.

The need for additional power plants may be one thing. But, curtailing emissions and getting such facilities sited is another matter. Americans expect the lights to remain on all the time while paying as little as possible, says Michael Morris, CEO of American Electric Power at a conference sponsored by Standard & Poor's. They "are trying to figure out how to get to heaven without dying."

At the same time, Morris says that regulators and other policymakers must continually be informed when it comes to energy industry matters. Reliability and financial issues are complex and must always be conveyed to decision makers. Power companies survive by providing good service, he says, and are always vigilant when it comes to ensuring customers receive superior products and services. "You've got to get a working relationship when you are asking for something."

Constructing power plants, of course, is a much riskier proposition than it used to be. With deregulation, the burden is on power-plant operators to run at maximum efficiency and to find buyers for their electricity, preferably before the first shovel goes into the ground. Without such measures, they couldn't get the financing. Still, there's risk. And that's why investors are demanding at least 10 percent earnings growth -- a good bit higher than the 2 percent earned traditionally under regulation.

To maximize productivity, some companies have tried to achieve size and scope and have built state-of-the-art facilities that burn fuel cleanly and efficiently. It's all to win fast approval and to cut the cost of operations. During the late-1990s, companies perceived an energy shortage and worked to acquire or build such plants to meet the expected demand at 2.5 percent annual growth.

"Cost overruns in construction are a key risk for us," says David Sokol, CEO of MidAmerican Energy, at the S&P conference. Costs are 35 percent greater today, he says, creating "a huge headwind for the industry, which is now in a building cycle."

Cautious Lenders

Altogether, 122 plants have at least been started in the last decade, driving up debt levels from $23 billion in 1999 to $49 billion in 2001, says Thomson Financial Securities. Wall Street rewarded those companies initially, pushing the values on some independent power producers' stocks such as Calpine and Mirant through the roof; some independent producers traded at price-to-earnings ratios of between 20 and 30 -- oftentimes double that of traditional utilities.

The sky became the limit. But supply eventually exceeded demand and the Enron mess made lenders and investors skeptical. Some of the highfliers like Calpine and Mirant suddenly tanked. Simply put, the value reflected in the forward price of a kilowatt-hour came down. Investors then realized that the return on their capital invested would not be as much and their earnings would not be as great. Stock prices therefore dropped, which then hurt their currency in the market to borrow money.

Now utilities and in particular the unregulated "merchant" operators are trying to shore up their balance sheets. Mirant, for instance, has cut capital spending and is selling non-strategic assets to create more liquidity. It has also canceled or deferred at least 8,300 megawatts in projects that it had previously made public. Unregulated power plants are still troubled. And it may take some time to get the full use of those assets. In any event, investors and lenders will want to ensure that future projects are fully contracted before they would get built.

For the foreseeable future, most of the construction by investor-owned utilities will occur in regions where companies can support their trading and marketing activities and where the economies are expanding such as in Florida. That region is expected to experience an electricity demand of 1,000 MW annually. The Northeast, meantime, is short of supply. But strict environmental laws mean that mostly natural gas plants are being developed, which are more costly to operate in today's economy.

"There is a risk in (lack of) diversity of fuel sources," says Kevin Burke, CEO of Con Edison, at the S&P roundtable. "At the same time, it would be tough to get a coal or nuclear plant built in this part of the country." New York City will add about 1,000 megawatts in the next year.

Coal, generally, has a bright future. The Department of Energy is predicting that 87 gigawatts of new coal-fired generation will get built by 2025. That's 174 plants averaging 500 megawatts each that equates to a total investment of $119 billion. But the utilities doing the developing will be those with the deep pockets and those with balance sheets consisting of 60 percent equity and 40 percent debt -- the inverse of the late 1990s.

Today, the price of coal is about half the price of natural gas. If that spread continues, a newly constructed modern coal power plant could likely cover its fixed costs and reward shareholders. The challenge, however, for a new coal power plant is its much higher upfront costs and lengthy construction cycle.

Just about all utilities have spent the last five years paring down debt and beefing up balance sheets -- not taking on new risks. Power producers have learned that they, too, are subject to boom and bust cycles. They know that a balanced debt-to-equity mix and a diversified generation portfolio is insulation from future downturns. Now that the economy is looking up, some high-powered utilities are ready to roar, and to invest in modern generation.

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

Copyright © 1996-2005 by CyberTech, Inc. All rights reserved.