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Last updated: June 12, 2014 6:32 pm
Market volatility may be at 10-year lows, but it is still there, if one knows where to look. One intriguing spot: the US independent power producers. IPPs, also known as “merchant” or “competitive” plants, generate electricity. Power transmission is then left to utilities whose returns are mandated by regulators. This week the third largest independent was created when PPL Corporation separated its generation business from its utility. It combined those generating assets with a group of power plants owned by private equity firm Riverstone Holdings to form a new public company, Talen.
Talen and its IPP peers are a wager on the upward, if erratic, trajectory of electricity rates. IPPs have had a nice run of late – but the rally should not be enough to erase memories of high-profile busts.
The integration of generation and distribution is fading. Exelon recently expanded its regulated utility exposure through the $4bn acquisition of Pepco. Duke Energy, meanwhile, is trying to sell 11 midwest power plants.
PPL’s deal to jettison its power-generation business is cleverly structured. The combination with the Riverstone unit is tax-free and the 15 gigawatts of combined capacity is concentrated in two desirable regions: the densely populated mid-Atlantic and fast-growing Texas.
In an era of low returns, investors prefer that utilities protect their dividend (PPL’s yield is 4 per cent) and leave power price speculation to the likes of Talen. Of late though, speculation has been a good business. Shares in NRG Energy, the largest IPP, are up a third in the past year. A harsh winter helped it boost its 2014 cash flow outlook by a fifth. Over the longer term, the hope is that the price of natural gas and electricity demand both edge up, combining to boost power rates. Volatility, though, cuts in both ways. Prominent power producers Energy Future Holdings, Dynegy and Calpine guessed wrong on electricity prices (and capital structure) and found bankruptcy.
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