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By Robert T. McWhinney, Jr., Jacobs Consultancy
While it may be true the collapse of Enron Corp. could be cited as the root of all energy sector financial woes and diluted earnings represented in 4Q2001 annual profit reports, it clearly wasn’t the underlying trigger of them. Just as sports historians instinctively know that talented quarterbacks and coaches are catalysts of great teams and stellar sports seasons, energy historians may look back and note that Enron’s ongoing financial troubles were perhaps triggered more by strategy calls by the company’s own players and coaching staff than by a safety or corner blitz from financial analysts, regulators or the media. Corporate energy maneuvers clearly didn’t start with Enron’s collapse, nor will they end with Swiss-based UBS AG’s zero-upfront cash acquisition of EnronOnline and takeover of Enron’s prime downtown Houston facilities.
Post-Enron changes-shifts in rating agency requirements, a measured loss of confidence in the merchant model, demands for audits, transparency and added disclosure-will, however, likely affect all North American energy teams for seasons to come. In this pivotal election year, there are distinct new rules being applied by government agencies and elected official referees tasked with insuring both prudent, fair play (and, of course, influencing the November vote). Savvy executives are watching plays closely and taking appropriate defensive actions.
Expect the unexpected
Last year’s forward progress in asset development was abruptly halted following 4Q2001 monetization demands, and lead to 4Q2001 and 1Q2002 announcements of divestitures and staggering capitalization efforts to reduce debt/equity ratios. Among others, Calpine Corp., Mirant, Dynegy Inc., El Paso Corp. and Williams rose to the holiday challenge. CMS and El Paso even won new financial analyst fans with their independent ‘early’ asset divestiture announcements during 3Q2001 financial reports. El Paso creatively sought authorization to shed Coastal-acquired refining assets a year early. Quarterback offensive play callers and defensive coordinator directives must, by necessity, continue to change due to the instability of financial trading markets, certain South American economies, and key management teams as the industry experiences one of the grandest young talent changes since the 1976 college football red-shirt rule drastically changed the depth of traditional powerhouses.
Even if Alan Greenspan and most bullish economists are correct, and the United States economy bounces back into positive territory by 2Q2002, the ensuing rush to meet debt-to-equity ratios and favorable returns on equity will likely result in public fumbles, announcements of turnovers of prime energy assets/ properties, or ongoing cancellation penalty flags tossed for proposed power plants-whether potentially fueled by natural gas, coal, solar or wind. Hopefully no one underestimate’s GE’s creative uses for any of its 300 announced global commitments for F-technology machines (The U.S. version is the 60-Hertz, 170-MW class 7FA). Once deposits are made and a project is cancelled, just imagine GE’s market bargaining position.
A true cynic could claim that if enough major companies insist something must be so, then it won’t come to pass. Just when the entire producer industry screamed that gas prices must rise, they fell; if one hears chants that all new power plants must be gas-fired, expect Hitachi or Alstom to follow global successes by announcing participation in new U.S. coal-fired plants (how about nuclear?). If others are selling, then watch Columbus-based AEP, Royal/Dutch Shell, German-based RWE or small-cap players piece together bits of assets to expand their respective franchises. This year’s winning executives prepared attacks well in advance of play, designed complex strategies and anticipated blocks prior to the snap.
Beyond assertions that completing all announced projects would result in selective regional overbuilding, behind boardroom doors, no matter how its spun, current trends provide convenient excuses to dump unpopular projects, unwanted domestic or foreign assets, and/or raise cash-lots of it-to satisfy spooked rating agencies. Some may just not realize until the post-Super Bowl depression wears off that many Europeans aren’t visiting the U.S. to watch American football. They’re scouting for fire sales, and finding them. Once entrenched, they will likely expand. Just as American and European football sports have completely different rules, scoring and cultures, so too do various areas of US power-public power (reminding us it can work in California), investor-owned utilities (showing redeeming values), IPPs (will cancellation announcements continue indefinitely?) and rural cooperatives (regaining fans).
How much is too much?
It is not, however, likely that every single post-2003 power project will get sacked. Run the math. For an imperfect list, start with a detailed list of power plants; sort it by electric reliability council and fuelsource. Assuming one-third of announced projects won’t make it, and using a mid-2001 baseline of 283,000 MW of announced projects, it stands out that these may just be the first quarters for announcing significant reductions, not the last. Mid-January calculations reflecting reductions of 91,000 MW are not unreasonable considering more than 30,000 MW were dropped in 2000. Calpine’s and TXU’s announced cuts only added to the long list of injured players.
Will project cancellations lead to power shortages? Not yet. We calculate approximately 207,000 MW of capacity additions through 2003, including approximately 27,000 already online, plus 180,000 MW projected for 2003 operation. We are (admittedly slowly) moving toward national markets, so except where regional transmission limitations affect movement, or terrible market structures prevent equilibrium, the result of ‘underbuilding’ will not necessarily be shortages, but scarcity-induced high prices. Similarly, ‘overbuilding’ could result in regionalized lower prices.
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Still, in a recent review of approximately 65,000 MW of coal-fired power projects, despite the appearance of strong economic incentive, there is low probability for most Montana, North Dakota and Wyoming projects because ‘political will’ may not develop soon enough to justify building necessary electric transmission capacity to insure plant viability.
Tackling the numbers
U.S. power consumption grew 2.5 percent per year from 1994-2000. GDP grew, on average, 3.4 percent per annum 1990-2000, but a better 2000-2010 GDP forecast would average close to 3.0 percent (instead of 4 percent set out by some economists-a 4 percent GDP growth might be sustained for a few quarters as the United States recovers from recession, but a sustained 4.0 percent GDP growth would be the greatest peacetime economic expansion in U.S. history). Anticipated average power growth could be 2.6 percent per year from 2001 through 2010. Including a 15 percent reserve margin, this translates into approximately 22,000 MW per year of capacity additions, or just enough to keep up with demand growth since re-powering projects list total capacity after re-powering, not net gain.
Beyond additions to keep up with demand growth, there are thousands of MW of capacity that could be built to displace old (often junky) units currently in service that actually get dispatched. With few retirements, some old plants, especially old coal plants, are re-powered to take advantage of existing infrastructure & air permits. When calculating new or re-built units for existing plants, one common mistake certain to result in overestimated natural gas supply requirements is to continue to use the old 10,000 to 14,000 heat rates instead of the actual 6,000-7,000 ratings for newer units (depending on unit, manufacturer and actual usage).
Some economists swear declining Gulf Coast gas production will automatically drive up natural gas prices, but routinely overlook that both natural gas production and power consumption are declining. Therefore, using peak vs. non-peak breakouts from fuel-cost worksheets to determine estimated gas consumption, is 300,000 MW of new power generation excessive? Despite regionalized pockets of unmet demand, 30Tcf market discussions may be benched, at least for now. Instead, return to economic theory to apply representative demand/consumption calculations that will support both strong physical delivery capabilities, return on equity and debt/equity ratios. It can be done. It must be done.
Armchair wagering
Could large-scale contract cancellations result in future unmet power supply? Abso-lutely, but merely watching from the sidelines or armchair to determine potential winners and losers could be as difficult as betting on regular season play between the 49ers and the Cowboys. Who wins at the end of any particular match-up could change with play-by-play events, much the way Wall Street analysts and ratings agencies score power and gas companies, utilities and IPPs-deftly maneuvering available information with changing rating agency rules, constant/increasing turnover of participants and super-stars, and commands for improved debt/equity ratios, increased disclosure demands, audit requirements and correspondence retention obligations.
Quality analysis is tougher than it looks.
In football, once the opposing team’s defensive line is formed, the quarterback can call an audible but responding to credit rating agencies is more like baseball. It may appear to the cheering crowds to be a strategy game, but in the end, it demands one-on-one, reactionary play, depending on the pitches and the crack of the bat.
McWhinney, group vice president, consulting operations, Jacobs Engineering, is managing director of Jacobs Consultancy. Prior to joining Jacobs in 2000, he had been president and CEO of Stone & Webster Management Consultants Inc. since 1997. Among other assignments, he is responsible for 16 global Jacobs Consultancy offices and for overseeing the transition to a single unified consultancy from multiple consulting teams, each of which previously maintained independent identities, but which were all parts by Jacobs Engineering Group Inc. (Companies formerly known as Pace Consultant, Houston; CRSS-Sirrine, Atlanta; The GIBB Transportation Practice, London; Consultants from Stork Engineers and Constructors, Leiden, The Netherlands; Humphreys & Glasgow, London). Based in Pasadena, Calif., he may be reached at [email protected]; www.jacobsconsultancy.com.
