Spencer Soper | The Morning Call (Allentown, Pa.)
PPL Corp.’s decision this month to spin off its power plants into a new company represents the latest fallout from the natural gas boom that has disrupted the nation’s unregulated electric industry.
Companies that make electricity hoping to sell it for a profit have been in a protracted slump, forcing some into bankruptcy or to sell off power plants. It is a boom-or-bust business vastly different from the stable returns and dividends offered by making and delivering electricity under government regulation.
The prolonged bust cycle has prompted diversified energy companies such as PPL to rethink the strategy of dabbling in both businesses at the same time.
The big game-changer is the shale gas boom, which has provided an abundant and affordable fuel source for power plants while diminishing the value of coal-fired electricity. PPL has produced about 40 percent of the electricity it sells in free markets by burning coal, leaving the Allentown utility vulnerable to falling natural gas prices.
The performance of PPL’s unregulated power generation business tells the tale. In 2008, when natural gas prices for electric generation peaked at $12.41 per 1,000 cubic feet, PPL’s power generation segment had operating income of nearly $1.4 billion, its highest amount in the past decade. The high natural gas prices increased demand for PPL’s lower-cost coal-fired electricity, which it could sell at a premium.
The following year, natural gas prices plummeted to about $4 per 1,000 cubic feet. PPL’s power generation income dropped 57 percent to $587 million as prices for its electricity slumped.
PPL’s regulated electric delivery business, meanwhile, has been shielded from the volatile swings of power plant fuel prices. Regulated utilities can pass the cost of procuring and delivering electricity to customers, which makes their earnings relatively stable and predictable.
For that reason, PPL has spent the past several years and billions of dollars buying low-risk utilities in Kentucky and the United Kingdom. In 2010, it purchased Louisville Gas & Electric Co. and Kentucky Utilities Co. for $7.6 billion. A year later, it acquired Central Networks, a power grid in England, for $5.6 billion.
Spinning off its unregulated power plants completes its transformation from a company heavy in volatile electric generation to one focused on the more stable electric delivery business.
“We’re not alone in this,” PPL spokesman George Lewis said. “Investors have a very different view of these businesses and they aren’t sure what to make of these hybrid companies.”
When the spinoff is complete next year, PPL Corp. essentially will be a regulated utility serving more than 10 million customers in England, Wales, Pennsylvania and Kentucky. It is expected to continue to provide stable returns for investors. It is also expected to have a better credit rating, which will lower its cost to borrow money to upgrade the electric grid.
Meanwhile, PPL will combine its unregulated power plants with 15 others owned by the private equity firm Riverstone Holdings to form Talen Energy, a new Fortune 500 company that can produce 15,320 megawatts of electricity, or enough to power 15.3 million homes. About 80 percent of that electricity will serve the mid-Atlantic region of the PJM Interconnection, which includes Pennsylvania. The new company will also own power plants in Texas, Montana and Massachusetts.
Unlike a regulated utility, Talen Energy’s performance will depend on a wide variety of factors. The spread between coal and natural gas prices will continue to be key. Environmental regulations also will play a role, as new requirements can make coal plants more costly to operate. Subsidies for solar and wind power will create new competitors to keep prices in check. Economic and weather patterns will influence electric demand and prices.
“These are diametrically different businesses,” said Paul Patterson, an analyst with Glenrock Associates in New York. “Electricity is one of the most volatile commodities out there because there is no way to store it.”
Splitting the businesses into two companies leaves investors to decide where they want to put their money. Under the current structure, investors have to buy PPL stock and accept its mix of low-risk utility assets and high-risk power generation. With two companies, investors can tailor their own mix of the two businesses.
“It’s a smart move,” Patterson said. “I don’t think there’s any justification for keeping them together.”
The new strategy and the pressures of natural gas prices aren’t unique to PPL.
Duke Energy, the nation’s largest utility, based in North Carolina, in February announced plans to sell all of its unregulated power plants in Illinois, Ohio and Pennsylvania due to their “volatile returns.”
In April, Texas power company Energy Future Holdings filed for bankruptcy protection as low natural gas prices left it unable to pay down debt.
Last year, Ameren Corp. in St. Louis sold its unregulated power plants so it could focus on its regulated electric and gas utilities in Missouri and Illinois. Dynegy, the Houston company that bought Ameren’s power plants, is hoping natural gas prices rise and the value of coal-fired electricity increases in coming years.
Those factors would bode well for the new Talen Energy, as well, which will profit most when demand for electricity rises along with the price of natural gas.
“Higher natural gas prices or a pickup in electricity demand could change things quickly,” said Ken Rose, an industry expert with Michigan State University’s Institute of Public Utilities. “Energy prices have been very cyclical for the last four decades, boom then bust, then repeat again. So market conditions today may be very different a couple years from now.”
The Talen spinoff, which needs approval by the state Public Utility Commission and various federal agencies, is expected to be completed in nine to 12 months. Talen then would be a Fortune 500 company listed on the New York Stock Exchange. PPL has said the company’s headquarters will be in Pennsylvania, but hasn’t specified where.