Bankruptcy’s Silver Lining for Energy Future’s Coal

Bankruptcy may be the best thing to happen to Energy Future Holdings’ coal-burning power plants.

Saddled with $49.7 billion in debt under the stewardship of private-equity firms that included KKR & Co., the Texas electricity generator is poised for a turnaround after emerging from bankruptcy court. Its five coal plants, some at risk for closure, will have more staying power as debt gets slashed, higher natural gas prices boost profits and concerns about grid reliability increase their value.

“Those plants are going to continue to run as long as they make money and they will be even more profitable if gas prices rise,” said Joseph DeSapri, a credit analyst for Morningstar Inc.

Energy Future filed for bankruptcy yesterday after months of negotiations with creditors, owners and management yielded a plan to eliminate $26.1 billion in debt. The Dallas-based company, formerly known as TXU Corp., said it hopes to exit bankruptcy within a year.

Coal-fueled plants owned by Energy Future’s generating unit, Luminant, make up almost 11 percent of total power supplies in Texas and are considered a key safety margin in the state where booming demand threatens to outstrip capacity. Creditors including hedge funds and other investors stand to take over the units - some more than 40 years old - for cents on the dollar after KKR, TPG Capital and Goldman Sachs lost billions on them in the biggest leveraged buyout in history.

Market Bottom

“This is probably the bottom of the market for coal plants,” said Michael Webber, deputy director of the Energy Institute at the University of Texas.

Coal, to the consternation of people trying to kill it, is showing surprising resilience everywhere. Rising gas prices already are pushing utilities to switch from gas-fired generation back to cheaper coal at levels not seen since 2011.

Worldwide, it’s the fastest growing energy source, projected to rise 2.3 percent a year through 2018, and poised to dethrone crude oil as the largest source by 2020, the International Energy Agency said in its December Medium-Term Coal Market Report.

Still, betting on coal isn’t without its risks. The shift back is happening in the face of campaigns by environmentalists and public health experts to reduce its use because of air pollution concerns.

Pollution Controls

Energy Future has said it will need to spend more than $1 billion on pollution control equipment through the end of the decade. The tab could rise higher if new state or federal restrictions on air pollution come down the pike. The U.S. Supreme Court yesterday upheld new federal air pollution rules that could hurt Luminant, though how those rules will be applied won’t be sorted out for months or years.

In addition, low-cost wind power is starting to flood the market and depress electricity prices.

Energy Future’s debt holders shouldn’t assume the oldest coal plants will generate enough money to pay off new debt, said Tom “Smitty” Smith, director of the Texas office of consumer advocate Public Citizen.

The majority of Luminant’s power plants already have installed emission controls that will allow them to run for several years, said Michael Granowski, a principal for energy consultant Enovation Partners LLC. Coal-fired units generated about 70 percent of the electricity from Luminant last year. Profit before interest, taxes and other items are estimated to climb 34 percent to $1.3 billion in 2017 on rising prices for Luminant, according to a March 26 report by Morningstar.

Interest Costs

Energy Future was taken private for $48 billion in 2007 by an investment group led by KKR and TPG Capital. The acquisition was essentially a bet that gas prices would rise, boosting electricity rates, which are based on gas. Instead, prices plunged about 85 percent from 2008 to 2012.

To make matters worse, the company’s declining revenue was choked by high interest payments. In the 12 months ended in September, 46 percent of Energy Future’s sales went to pay debt interest, according to data compiled by Bloomberg.

The reduced debt post-bankruptcy will provide more potential profit to creditors positioned to take over the company’s power plants.

“The Luminant bankruptcy is not so much an issue of plants that were not economic, but instead an extremely over-leveraged bet that natural gas prices would remain high,” said Ed Hirs, a professor at the University of Houston who specializes in energy economics. “This was financial engineering at its worst.”

Still Necessary

The Electric Reliability Council of Texas, which operates the grid that serves most of the state, said yesterday it expects Luminant’s plants to continue operating during bankruptcy and has no immediate concerns about system reliability.

After a financial restructuring, many of the company’s coal-burning units with pollution controls “will be profitable in the market and will continue to be necessary,” Granowski said.

Already, the tide appears to be turning for the plants. In February, Luminant brought three coal units mothballed for the winter back into production sooner than planned due to rising gas prices, which have doubled more than $4 per million British thermal units in the past two years.

Electricity prices are based on the cost of gas in most markets because gas-fueled plants are usually the last to be brought online to provide power during hours of peak demand.

It is now more profitable per megawatt to burn coal compared to natural gas as prices for gas have risen, according to data compiled by Bloomberg.

Cheaper Coal

Coal plants generally have fixed fuel costs so higher prices flow directly to earnings, said Andy DeVries, a credit analyst for CreditSights Inc. For Luminant, which also owns a 2,300 megawatt nuclear generator, a $1 increase in gas prices equals an additional $700 million in revenue, he said.

In the meantime, a long, cold winter that strained power supplies and threatened blackouts from Southern California to New England hammered home the importance of having enough generating capacity to keep the lights on when demand is highest. In Texas, where population growth has outpaced new generation, peak demand usually coincides with hot summer months when air conditioners burden the grid.

Texas generators have delayed building more capacity as they’ve waited for new state policies that would help them pay for the plants. That’s made existing coal plants more critical in the near-term. Texas consumes more coal than any other state to burn for electricity.

“There is nothing that prints money quite like a paid off coal plant,” said Webber. “Those are money makers.”

(Corrects story published April 30 for proper spelling of company name in 13th paragraph.)
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