Cheap Natural Gas Lures Private Equity to Power Industry

By Jonathan N. Crawford and Naureen S. Malik  

The companies most bullish on U.S. power aren’t energy companies. They are private equity firms and here’s why: natural gas.
Firms from Panda Power Funds to Energy Investors Funds are financing about 10 gigawatts of new gas-fired plants over the next five years in the 13-state mid-Atlantic grid. That’s enough power to run New York City on all but the hottest summer days. Traditional power companies are building less than 4 gigawatts. Part of the electric grid sits atop the Marcellus shale formation in Pennsylvania, which supplies 18 percent of U.S. gas production, up from 1.8 percent in 2007.
Gas from the Marcellus shale deposit is helping boost U.S. production to a record for a fourth year. Growing supplies have cut gas prices in
half over the past six years, double the drop in power, leaving investors with a healthy profit margin. Gas plants will account for about 27 percent of U.S. power output this year, up from 21 percent in 2008. Coal’s share dropped to 39 percent from 48 percent.
“The bet, if you will, that private equity seems to be making is that low gas prices in the Marcellus region will give them an advantage,” Swami Venkataraman, vice president and senior credit officer for infrastructure finance at Moody’s Investors Service Inc. in New York, said yesterday by phone. “They’re able to get an extra kicker in terms of their profitability by doing so.”
Henry Hub gas futures have averaged $4.31 per million British thermal units this year, down 52 percent from the same period in 2008. Power in PJM Interconnection LLC’s Western hub, a regional benchmark, is down 23 percent.

Higher Production

Natural gas futures added 2.1 cents to $3.655 per million British thermal units in electronic trading on the New York Mercantile Exchange at 11:59 a.m. Singapore time. The heating fuel has lost 14 percent this year.
Natural gas plants are being built to replace about 12 gigawatts of mostly coal generation in the mid-Atlantic grid managed by PJM. The plants are slated to shut through 2015, driven by new environmental standards on toxic air emissions.
“There’s a huge amount of generating capacity that’s coming offline,” said John Breckenridge, managing director at Capital Dynamics, a Zug, Switzerland-based company that invests in private equity. “You’ve got a lot of gas within PJM now because of the Marcellus shale, primarily. So gas-fired power plants are very attractive investments.”

Raising Money

The private equity companies are constructing the most efficient gas plants, which, near the Marcellus shale, may see a profit margin of $21.72 a megawatt-hour in January, based on gas deliveries at the Tetco M3 hub in PJM, according to data compiled by Bloomberg yesterday. That compares with a margin of $2.18 for the average combined-cycle plant in the area, and a loss of $30.38 for the least efficient gas units.
More than two dozen North American energy-focused funds raised $26 billion in 2013, the most in at least 14 years, according to London-based research firm Preqin.
“It feels like a lot of the pieces of the puzzle that you need to successfully develop and build a power plant are coming together right now,” Mark Voccola, partner at Energy Investors Funds, said Nov. 14 by phone from New York.
Funds managed by EIF will own a 705-megawatt gas-fired power plant in Newark, New Jersey, and will co-own an 869-megawatt plant in Ohio, both of which are under construction.
Firms developing plants near production fields can take advantage of cheaper prices at the wellheads. Gas at the Leidy hub in Pennsylvania has averaged $3.10 per million British thermal units so far this year, compared with $4.41 at the benchmark Henry Hub in Erath, Louisiana.

’First Guy’

Panda, the largest builder among the private equity firms, started up two gas-fired units in Texas this year with 1,516 megawatts of capacity and is building another 2,247 megawatts that will come online through 2016.
“The first guy wins, so our goal was if we can get there first we can have the market edge,” Robert Carter, chief executive officer and founder of Dallas-based Panda, said Sept. 25 at a ribbon-cutting ceremony in Temple, Texas.
Panda raised $571 million for a 778-megawatt plant in Virginia, according to a Nov. 17 e-mailed statement. It’s the sixth project the company secured in the past three years.
While private equity builds, investor-owned utilities and merchant generators have slowed spending on new plants.
“The price that you can see does not justify building,” David Crane, chief executive officer of NRG Energy Inc., the largest U.S. independent power producer, said Oct. 16 in New York.

Market Rules

Generators from Exelon Corp. (EXC) to Calpine Corp. have been lobbying for market rules to bolster power prices.
“Traditional utilities are refocusing on regulated service and leaving the riskier generation business to private equity,” said Julia Sullivan, an attorney at the Washington-based law firm Akin Gump Strauss Hauer & Feld LLP. “The generation market, as it becomes increasingly competitive, becomes more and more risky,” she said.
That doesn’t bother the private equity funds.
“For the record, we’re crazy, they’re smart,” Carter said. “Our competitors are absolutely correct. They shouldn’t be building anything. They’re smart, we’re crazy.”