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Electric Industry Capacity Glut Jolts Investors

by Rebecca Smith, Staff Reporter
Wall Street Journal - November 11, 2003

Promise of Deregulation Fuels Construction Spree;
Surfeit in the Southeast

The U.S. electric-power industry, lured by the promise of deregulated markets, has added far more generating plants than will be needed for years, a building boom that has thrust the industry into its biggest financial bust since the early 1980s.

The construction spree hit full stride two years ago, just as the electricity market softened due to the economic downturn and as public misgivings about continued energy-market deregulation crested. In the continental U.S., nearly 200,000 megawatts of new generating capacity -- the equivalent of 400 big power plants -- has been added since 1999, boosting the total by 24% at a time when demand had flattened out.

Transmission bottlenecks and widespread overcapacity in many cases keep electric companies from selling their excess power to other users. Nor will a rebounding economy provide much solace. More energy-efficient industrial plants and the migration of factories overseas means "manufacturing is not there to help the electric sector get out of this hole," says Peter Rigby, energy analyst at Standard & Poor's.

Despite the surplus generating capacity in many parts of the country, the big Aug. 14 blackout in the Northeast and parts of Canada, the specific causes of which are still being investigated, appears mainly related to problems in how the nation's electrical-transmission system is managed.

The last time the electric industry was in this much trouble was 20 years ago, when utility customers and shareholders shouldered billions of dollars of cost overruns from nuclear-power plants. The latest downturn is the first since regulators a decade ago created a wholesale market where electricity could be bought and sold at competitive prices by unregulated, or merchant, suppliers. That means the current troubles are being borne by investors and bankers who financed the merchant companies' building spree.

No region has a greater surfeit of electrical capacity than the Southeast. Since 1999, more than 51,000 megawatts of capacity have been built in a nine-state region that extends from Louisiana to Virginia, excluding Florida, boosting energy capacity by a third. Plentiful supplies of natural gas for fuel encouraged the overbuilding. In Mississippi, for example, 9,871 megawatts of capacity have been added by merchant power-plant developers since 1999 -- more than doubling the 7,518 megawatts that existed beforehand, according to Platt's, a division of McGraw-Hill Cos.

The surplus in Entergy Corp.'s utility territory in Texas, Louisiana, Arkansas and Mississippi approaches 80%. Put another way, it means suppliers could produce nearly twice as much electricity as customers of the New Orleans-based utility will need on the hottest day. That is six to 10 times as much capacity as utilities like to keep in reserve.

With such a glut, Teco Energy Inc. of Tampa, Fla., recently suspended construction on a nearly completed plant at McAdams, Miss., down the road from the Attala plant operated by San Francisco-based PG&E Corp.'s National Energy Group unit, which is under bankruptcy-court protection.

Nor are the region's electricity suppliers readily able to ship the power to other areas. To the west, transmission connections peter out, since Texas has its own electric grid that isn't synchronized to the Eastern Interconnection of power lines. Areas to the north already are oversupplied. Even if they wanted some of the Southeast's excess, there isn't enough space on the power lines to move very much of it north.

Such transmission-access problems are likely to get worse. It appears that the biggest energy bill in a decade, now being debated by congressional conferees, will give Entergy, Atlanta-based Southern Co. and other utilities the right to reserve as much space on their power lines as they say their customers need. In some cases, this will freeze out merchant suppliers and their customers.

The glut of power is creating financial burdens. Twelve of the biggest electricity suppliers, including firms such as Calpine Corp., San Jose, Calif., Cleveland-based Williams Cos. and Allegheny Energy Inc. of Hagerstown, Md., have taken on more than $120 billion of debt to fund their construction spree, roughly half of which comes due between now and 2010. But in many regions, experts don't expect a sustained recovery in demand or electricity profits until the end of the decade. Many firms are completing half-built plants rather than take a total loss, continuing to increase the surplus.

More Write-Downs Expected Power plants, both old and new, are generating billions of dollars in losses and charges that reflect their diminished value. In the third quarter, Atlanta-based Mirant Corp. took a $2 billion charge to write down the value of its plants. Houston-based Reliant Resources Inc. eliminated $1 billion in "goodwill." More write-downs are expected.

Duke Energy Corp., with nearly 16,000 megawatts of merchant capacity in its fleet, has only 30% of its potential electric output presold for 2004. That is slightly less than the amount covered by sales contracts this year, at 35%, and suggests some plants may not run enough to cover their costs. Duke spokesman Peter Sheffield said the Charlotte, N.C., company is doing its best to weather a difficult market and is "counting heavily" on profits from its regulated utilities.

How did this enormous reversal happen, especially since it looked like the nation was heading toward an energy shortage only a short time ago? Mainly, plants were built with assumptions about demand growth and the evolution of electricity markets that haven't come to pass.

A backlash against deregulation hurt the new merchant suppliers after California's experiment in energy deregulation produced sky-high prices in 2000 and 2001 that bankrupted its energy auction. In late 2001, sector pioneer Enron Corp. collapsed amid accusations that it had manipulated markets. These two developments largely halted the growth of auction markets that would have given new suppliers an edge over owners of older, fuel-guzzling plants.

Other factors also have hurt. Natural-gas prices have gone up sharply, making gas-fired plants less competitive against coal-fired plants. Another blow was the Bush administration's decision to weaken industrial-pollution rules, effective next month, which means that old power plants no longer face costly upgrades and can undercut newer, cleaner plants with high capital costs.

'Fairly Desperate Characters'

This has left many companies with state-of-the-art plants, but too few buyers for the output. "We and our industry are fairly desperate characters these days," says Richard Lehfeldt, senior vice president at Teco Energy, which owns the two largest gas-fired plants in the nation. He says suppliers will sell electricity for extremely low prices just to have some cash flow. "Even a welfare rate of return is better than no rate of return."

Lenders, so far, have been willing to extend debt maturities rather than press the issue. But Mr. Rigby, the Standard & Poor's analyst, says there's evidence of growing "lender fatigue." "As the economy picks up," he says, "the banks may be willing to take more write-offs and let the companies go into bankruptcy."

Rebecca Smith, Staff Reporter
Electric Industry Capacity Glut Jolts Investors
Wall Street Journal, November 11, 2003

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