Credit markets 'wide open' to competitive power, despite public pullback

The appetite of lenders to finance competitive power portfolio acquisitions and new-build fossil generating projects is unlikely to be subdued in the short term, even if incumbent power generation companies trade at persistent discounts in the public markets.

While Calpine Corp., Dynegy Inc. and NRG Energy Inc. continue to take it on the chin from public investors, there appears to be no shortage of credit available to private equity groups like Blackstone Group LP, ArcLight Capital Partners LLC and LS Power Group when it comes to financing their own recent portfolio deals.

In fact, the three outfits have successfully tapped the term loan markets in 2017 to finance their acquisitions of the American Electric Power Co. Inc. and TransCanada Corp. power portfolios via Lightstone Generation LLC and Helix Generation LLC, respectively. In the case of LS Power's Helix portfolio, its term loan raise was oversubscribed and subsequently upsized to $1.68 billion from $1.54 billion, according to a March 7 report from S&P Global's Leveraged Commentary and Data.

That level of institutional fervor around privately led term loans for larger deal portfolios appears likely to continue well into 2017, particularly for assets that offer some unique upside, whether it is a geographic advantage akin to Ravenswood's placement in New York's Zone J, or unique structural benefits employed by Lightstone for its PJM Interconnection portfolio.

"The capital markets are very robust and supportive from a term loan perspective for these power generation assets, in part because there is so much capital available … versus the amount of product out there," Morgan Stanley Global Power and Utility Group Managing Director Scott Beicke said at the Moody's Power and Renewable Energy Conference on March 15. "Over a long period of time, the markets have been wide open from a credit perspective."

For its part, Morgan Stanley has led a pair of term loan raises for both Calpine and Dynegy, helping the former refinance its 2023 debt maturities and the latter to finance its buyout of the ENGIE North America power portfolio. So too has Vistra Energy Corp., the rebranded retail and generating arm of the former TCEH, been able to tap the credit markets to reprice its own $3.5 billion term loan package, in an effort led by Deutsche Bank.

'Cash is king'

As the first quarter of 2017 nears completion, the refrain appears to remain true that investors possess an outsize pool of cash and credit relative to the selection of quality power assets. So long as competitive power assets offer healthy positive free cash flow, private equity investors and their institutional counterparts are likely to be satisfied with targeted investments in the sector.

Compared to public markets, the factors that determine relative value in the private context are more distilled. "Cash is king," Beicke said, highlighting the fundamental ability of an asset to produce cash flow as the first step in forming a private investment thesis.

Cash generation as the core maxim for private investors, compared to the need to grow earnings, manage costs and pay dividends in a public context, continues to define the disconnect between public and private valuations and the increased prevalence of shareholder activism.

"There is still money interested in the sector ... but it has been a struggle for public investors in Calpine, Dynegy and NRG, and I wonder if folks are just asking themselves if it's even worth spending time on these IPPs," Energy Capital Partners' Principal Andrew Gilbert said at the Moody's forum, noting the erosion of long-only ownership in the IPPs and the lack of dividend distributions.

"Not being able to produce consistent growth is a challenge as a public company," Gilbert added. "For someone like ECP, [we] do not need the businesses we look at to grow 10% a year in order to make money … and we are fine purchasing an asset that we may sell for less than we purchased it for in five years," assuming the cash flows are still accretive.

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An increase to the Federal Reserve's funds rate is unlikely to weigh heavily on prospective new-build projects, particularly where capacity performance payments underpin investments in efficient, new gas-fired projects in PJM and ISO New England.

Rate hike impact

The new normal, however, is one in which the cost of capital is so low on the debt side and the competition so robust that the market for new build will show little impact from the marginal rate increase of 25 basis points, Moody's Investor Service Associate Managing Director for Global Project & Infrastructure Finance A.J. Sabatelle told S&P Global Market Intelligence on March 15.

"I think interest rates are still pretty low … I can remember when the prime rate was 13%, and projects still got built," Sabatelle said, but did caution that the rate increase "could have implications around refinancing and reduces the amount of debt that can ultimately be raised."

Indeed, PJM alone could see about $75 billion poured into new combined-cycle gas investments through 2020, according to an S&P Global Market Intelligence analysis Feb. 8, representing the possible addition of about 23,000 MW of new capacity.

But Beicke warned that if institutional and commercial project lenders begin experiencing impairments in their investments, or downturns in relative asset values, the credit markets could tighten up.

'Oncoming train'

While publicly-traded generators grapple with perceived distortions to the markets in which they operate from nuclear subsidies, near-term upside may be too closely tied to expectations for capacity auctions in PJM, NYISO and MISO, which UBS Securities LLC views as "all skewing poorly," according to a March 16 note.

How state nuclear subsidies are interpreted by FERC and the courts will drive changes in the structure of U.S. competitive power markets, where some market participants may favor gas-fired assets as the bedrock of a more renewable-intensive, intermittent grid.

"Fundamental change often breeds opportunity," Morgan Stanley's Beicke said. "When you go from an industry that is heavily reliant on baseload assets like nuclear and coal ... to one that is more focused on gas and renewables, that heavy reliance on renewables envisioned in the future is going to put a premium on reliability and capacity."

"It will be interesting for the quick-starting gas assets ... to see what sort of market changes there are that allow them to stay in place and what sort of economic rents can be extracted when we have some downturn in wind and solar production," Beicke added.

Still, a recovery in public market sentiment around competitive power, and the re-emergence of the traditional private equity exit strategy to take a company public, are unlikely to surface without a commodities price rally. Many industry observers apparently see such a rally as unlikely, given the new build boom and commodities price volatility.

"The sector often sees a light at the end of the tunnel," Moody's Senior Vice President Swami Venkataraman said, referring to a time when tightening Northeast natural gas supplies prompted anticipation of strengthening spark spreads. "But the light turns out to be an oncoming train."

"If you are thinking about building a merchant generator now, it is tougher to say three-to-five years from now, 'I am going to take that business public and receive 8-10x multiple on my cash flows,'" ECP's Gilbert said. "Two years ago you were pretty comfortable that that market was there, but today it's much less certain."