ELECTRICITY

A tale of 2 power producers: how NRG and Dynegy chose different paths

Dynegy Inc. and NRG Energy Inc., two of the nation's largest independent producers of electricity, would seem to be almost like brothers. They are among the few of their kind left standing after wrenching cycles of boom and bust. Both burn vast amounts of coal and natural gas to keep the nation's lights on.

But in the past few years, the two companies have begun growing in drastically different directions, with one continuing to lay its bets almost entirely on fossil fuels and the other making huge, daring investments in solar farms, carbon-capture plants and electric cars (EnergyWire, Sept. 9).

The contrast is especially striking given how, in many other ways, Dynegy has acted like a younger brother to the larger NRG -- filling its executive suite with former NRG executives, following it into retail markets, even copying the layout of NRG's offices.

In August, it became even more apparent that Dynegy has chosen to follow a traditional path as NRG looks to expand in new areas of energy delivery.

Dynegy announced two acquisitions, valued at more than $6 billion, that would nearly double its generation capacity to almost 26,000 megawatts, mostly in coal and gas (EnergyWire, Aug. 22). That same month, NRG announced a corporate restructuring that would have each of its three divisions devote at least some focus to low-carbon businesses.

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"It seems like there's just two very different approaches," said Jon Cohen, formerly an analyst with ISI Group. "Their focuses are on just different time periods."

Cohen said David Crane, the leader of NRG, sometimes seems "more excited by and more focused on" longer-term strategies like solar and carbon capture, even as his company manages a giant portfolio of fossil fuel plants. Meanwhile, Cohen added, "Dynegy is exploring ways to just reduce costs, improve efficiencies, doing things around the edges to maximize the profitability of their existing portfolio."

Some electric companies operate just as regulated utilities. Others, including Exelon Corp. and Entergy Corp., have power plants in competitive markets as well as traditional utility assets.

Independent power producers, or IPPs, are a different animal. They're riskier by nature because of a focus on merchant plants. They don't go to state utility regulators and ask for a rate of return for their investments. They are out in the market and subject to the ups and downs that come with it.

Different approaches

The U.S. IPP sector has been in a near-constant state of change over the past 15 years as companies have faced financial distress and, in many cases, bankruptcy. The main publicly traded survivors are three -- NRG, Dynegy and Calpine Corp.

A fourth, Talen Energy Corp., is expected to debut next year as a company that would include a combination of merchant assets from PPL Corp. and Riverstone Holdings LLC. The planned split from PPL is part of a trend that sees value in so-called pure plays with a clear story to tell.

With utilities and merchant power plants, "you have different business models, different risk profiles, different investor expectations," said George Lewis, director of corporate communications at PPL.

Unlike Dynegy or Talen, NRG sometimes has difficulty telling a simple story because of its wide range of electric holdings. Company executives have fielded questions about whether NRG is dipping into too many areas.

The sector's focus was more diverse around the year 2000, as companies sought to expand in many directions, from domestic to overseas operations. Some power producers emerged from traditional utilities, while others developed on independent tracks.

With expansion in the late 1990s and early 2000s, independent power producers saw an increase in debt as they added more capacity than the grid could use. Some producers went under as the market softened.

NRG filed for -- and exited from -- bankruptcy in 2003, setting the stage for its rebirth nearly a decade before Dynegy would emerge from its own insolvency.

NRG added to its portfolio of plants that run on fossil fuels, but it also pushed into emerging areas with everything from large wind installations and electric vehicles to rooftop solar programs and mobile power sources. It also made a key purchase in 2009 with the acquisition of the Reliant Energy retail business, which provided a platform to interact directly with end-users. Dynegy entered retail about four years later.

NRG has had stumbles along the way, including an attempt to expand its U.S. nuclear capacity before a Japanese tsunami tabled the appetite for that plan. But in its own way, NRG is bringing diversity back into its part of the electricity world.

Dynegy has undergone a reboot after a combination of debt and lower power prices put it under pressure, and Carl Icahn, the billionaire investor, failed in an attempt to buy the company. A Dynegy holding company filed for bankruptcy in 2011. Then came a Chapter 11 filing in July 2012 for Dynegy and an emergence from bankruptcy in October of that year.

Crane and Flexon

While Dynegy and NRG are in different phases of a corporate life cycle, both retain a healthy appetite for acquisitions.

NRG is led by Crane, the CEO who frequently questions the regulated utility business model and talks about the need to pursue clean energy. He took the helm at NRG as it was emerging from bankruptcy. Crane frequently talks about the need to give consumers what they want, even writing a manifesto on why the power industry should be more like Google Inc. and Apple Inc. (EnergyWire, March 31).

Dynegy's CEO is Robert Flexon, formerly Crane's right-hand man at NRG with titles such as chief financial officer and chief operating officer. "They were a very strong team," said Shiran Kochavi, a former senior counsel at NRG.

Flexon, who has spent time at UGI Corp. and Foster Wheeler AG, was on the board of Dynegy as it was undergoing restructuring and was chosen to lead the company in 2011.

Flexon oversaw Dynegy's acquisition last year of assets in Illinois from Ameren Corp., and he agreed to the recent deals that would nearly double the company's generating capacity. The company has said it will be focused on integrating its holdings and running its business. Flexon did indicate in an interview with the Houston Chronicle that more expansion is possible.

Dynegy's current operating capacity fuel mix is about 54 percent coal and 45 percent gas, but that would flip to 54 percent gas and 45 percent coal after planned acquisitions, according to a recent presentation. Oil would remain about 1 percent.

"For the short term and the midterm, all types of fossil generation will continue to be an important part of economic, environmentally compliant energy," said Katy Sullivan, director of public relations and internal communications at Dynegy. "And that's good for consumers, as well as independent power producers."

The company's Ameren transaction included a retail operation, and Dynegy's planned acquisitions will bring a retail component from Duke Energy Corp. Dynegy has indicated that it sees benefits to having retail businesses near its generation assets.

At NRG, about 47 percent of generating capacity is fueled by natural gas, compared with 31 percent from coal, 11 percent from oil, 8 percent from renewables and 2 percent from nuclear, according to a company presentation.

Andrew Bischof, an equity analyst with Morningstar Inc., said he expects Dynegy to follow a relatively traditional path.

"They haven't indicated or made any moves that they would move away from that core" of generation fueled by gas and coal, he said.

Changing the office

For Dynegy, the attempt to refocus came in 2011 as leaders rolled out a program to promote efficient operations.

Another change came at the end of April 2012. Out was the company's spread of offices over multiple floors at one of Houston's tallest skyscrapers. In was an open concept on the 14th floor at a more modest building.

The office revamp was an idea that came from NRG, and it allowed executives and employees to communicate and collaborate while promoting transparency.

"We enjoyed that model, and we thought highly of that model, and we did bring that here to Dynegy," said Carolyn Burke, Dynegy's chief administrative officer. Four of Dynegy's top six executives have several years at NRG on their resumes, including Burke.

While it's still recovering from bankruptcy, Dynegy has seen favorable reviews.

UBS Securities issued a report last month to reiterate the "upside" potential it sees in Dynegy shares. It called the company "the most appealing power stock," noting exposure to possible improvements in areas overseen by PJM Interconnection LLC and the Midcontinent Independent System Operator as well as in New England.

"When you look at their pro forma portfolio, the reality is they've got exposure to some of the best markets," Julien Dumoulin-Smith of UBS Securities said in an interview.

Dumoulin-Smith said issues related to coal remain, and he said more natural gas assets would help to provide diversification. No big renewable plans appear on the near-term horizon at Dynegy.

"Our primary business is the large-scale, traditional generation facilities," said Dynegy's Sullivan. "We don't have any plans to branch out into rooftop solar or distributed energy. However, our retail business is doing some limited energy efficiency programs with our commercial and industrial customers."

Bischof said Dynegy came out of bankruptcy as a relatively small IPP before making moves to expand its portfolio.

"There is something to be said about being able to drive scale in terms of overhead and being able to price coal contracts, that there is advantages to having scale," he said.

While the company plans to add debt, Bischof said he thought it was good to get plants at a reasonable price that are well-positioned, especially gas units. He said the company retains a certain risk because of its business.

"In the long term, at the end of the day, you're still a commodity producer," he said.

Looking to the future

Another wild card for the sector is potential regulation of greenhouse gases tied to climate change. U.S. EPA has proposed reductions in carbon dioxide emissions that, along with other regulations, could put a squeeze on coal-fueled plants at any number of power companies.

Dean Ellis, managing director of regulatory affairs at Dynegy, said EPA's plan could be a significant rule, and he called a target on heat rate gains "more aspirational than practical." EPA has discussed possible average heat rate improvements of 6 percent for coal steam electric generating units as a way of boosting the efficiency of plants.

Dynegy could see an additional 1.5 percent boost after earlier improvements, but that could require structural changes in the power market, Ellis said. The company is looking at possible alternatives, he said.

Among investors, the line of sight often is the next few years. That leads to a question of how projects and plans that go out 20 years or more are being valued.

California is a place where the future may be visible, as a company could have issues with merchant gas plants because of renewables, distributed generation and energy efficiency programs, said Cohen, the former ISI analyst.

He said there may be a need for fast-ramp plants as the sun sets, and units that can provide a lot of power quickly will be worth something.

Electric companies are exposed to the same underlying issues, such as weak residential and commercial demand, low gas prices, more stringent environmental regulations, and distributed generation, Cohen said. Crane seems convinced big change is coming.

"I think the other companies probably think that it's going to take a long time for that to happen, and in the meantime, there's a lot of money to be made in the traditional merchant energy business," Cohen said.

If someone believes in technology, Cohen said, NRG over the long run probably is adopting the right strategy. He called himself a believer that "the IPP business model is probably going to come under pressure."

That's something Crane discussed during a recent earnings conference call. NRG also has talked about competing with SolarCity Corp. on rooftop installations, which is not something heard from Dynegy.

"I don't think Dynegy or Calpine is going to rush into any of these alternative technologies," Cohen said. "I think they'll leave that to NRG and SolarCity and others."

Twitter: @edward_klump | Email: eklump@eenews.net

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