TXU's emissions U-turn shocks power industry

By _Jasmina Kelemen_ (http://www.marketwatch.com/news/mailto.asp?x=106+107+101+108+101+109+101+110... 533-a7e8-cc903d8e243b}&siteid=mktw) , MarketWatch, February 26, 2007

HOUSTON (MarketWatch) -- TXU Corp.'s decision to whittle down plans to build 11 carbon-spewing, coal-fired power plants as part of its buyout deal with private-equity firms sent a chill Monday through both Wall Street and Washington, signaling that utilities can no longer afford to ignore climate change.

But with coal becoming too toxic to handle, nuclear plants taking too long to build and natural-gas prices going through the roof, little in the way of specifics is being offered on how utilities will provide clean and affordable power to an energy-hungry nation as more states push to deregulate their electrical grid and open it to the market's machinations.

Environmentalists cheered the announcement that TXU was axing eight of 11 coal-fired power plants that it had planned to build in Texas by 2010 as part of a $45 billion buyout deal with Kohlberg Kravis Roberts & Co., Texas Pacific Group and Goldman Sachs Group.

Prior to announcing the largest leveraged buyout in corporate history, the private equity firms spent about two weeks negotiating with powerful environmental groups to fashion a takeover proposal that would bring the activists on board and head off any potential costly litigation.

"The decision by the buyers to reach out to our organization reflects a conclusion by the business community that they can't simply ignore global warming and come up with sound business strategies," said Dave Hawkins, director of the Natural Resource Defense Council's Climate Center during a call with journalists. "It's an earthquake that happened in Texas but the shock waves will be felt in Wall Street and Washington."

People on Wall Street said the deal's ramifications went beyond the power industry, making it clear carbon emissions will be a factor for the entire economy.

"It's a wake-up call to the whole industry and the whole economy," said Jeffrey Holzschuh, a vice chairman at Morgan Stanley. "The auto guys, the airline industry, everyone" has to deal with carbon emissions now, he said.

Industry watchers in and outside the investment community consider it a near given that some sort of legislation restricting carbon dioxide emissions is on the horizon. For the power industry, this means balancing their customers' power needs against a hazy notion of potentially stricter air-quality regulations.

"It's very difficult to build and design a plant that would have the ability to control for emissions before they know what those regulations are going to be," said Mark Morey, a director at Cambridge Energy Research Associates.

In the 1990s, natural-gas replaced coal as utilities' fuel of choice, embraced as a cleaner and cheaper way to generate electricity while tapping secure and plentiful domestic supplies.

In fact, gas was so cheap, around $2 per million British thermal units, that many state regulators said it was time to open their power markets to competition, thinking deregulation would inject more capital investment into the sector.

For a time it worked.

In the past decade, most of the country embarked on an aggressive buildup of power plants, 99% of which burned natural-gas, said Charles Gaffney, a utility analyst that manages the Eaton Vance Utility Fund.

Not-so-cheap gas

Meanwhile, natural-gas prices have risen steadily, peaking around $15 per million Btu in the weeks after Hurricanes Katrina and Rita thrashed the Gulf Coast oil and gas fields, eventually leveling off just below $8 per million Btu.

Higher natural gas prices have meant higher electricity bills, especially in the states that have gone farthest toward deregulation, prompting many to demand lawmakers roll back plans to completely open their power markets and extend rate caps to shield consumers from rising costs.

As a result, utilities are once again searching for cheaper fuel, bringing coal and nuclear power back to the table. But nuclear power plants are hugely expensive and take far longer to build than coal-fired plants and therefore cannot be relied upon to quickly meet growing power needs.

"We are looking at potential (power) shortages say within 5-10 years if no new facilities are built," said Terry Hadley with the Texas Public Utilities Commission prior to the announcement of TXU's buyout deal.

Prior to agreeing to the takeover, TXU insisted Texas needed its 11 power plants or else the Lone Star State risked the rolling blackouts that beset California at the start of the century.

The Texas powerhouse has yet to spell out how it will replace the megawatts lost as a result of scrapping its plans and has not returned repeated calls and e-mails seeking a response.

Other than vague calls for more energy efficiency programs, analysts and activists cheering the deal are also largely sidestepping the question of what power source will fill the looming gap on the state grid while the industry and its stakeholders look to Washington for further clarification on carbon emissions.

But unless legislators mandate lower prices, electricity bills clearly will continue to rise along with the cost of generating power.

Around the country, there are about 150 new coal-fired power plants on the drawing board. Following TXU's move, many will likely have to recalculate their expansion plans. "As utilities seek low-cost generation capacity, it's clear that coal continues to look attractive. But as air quality standards become more stringent, we expect the costs will continue to increase," said Eric Kane, an analyst with Innovest Strategic Value Advisors.

Jasmina Kelemen is a MarketWatch reporter based in Houston.

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