High risk, low reward drives shift from power generation - Houston Chronicle

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How did Texas get to the point where more than half its electricity generation got knocked offline?

The failure of so many power plants during the brutal winter weather that swept through Texas last month was perhaps years in the making, the result of a merchant power industry that has struggled to earn profits, satisfy Wall Street and keep the confidence of lenders and investors.

Squeezed by low electricity prices, tight margins and competition from cheap wind power, merchant power companies such as NRG Energy, Calpine and Vistra Energy have been reluctant to invest in new power plants or upgrade older ones, asserting for years that they were simply not making enough money from generating electricity.

Lenders and investors have agreed. A major new power plant — excluding wind and solar installations — has not been built in Texas since 2017, when the Chicago company Exelon completed two 1,100- megawatt gas-fired power plants, according to the Electric Reliability Council of Texas, the state’s grid manager. One reason: financing for projects that can cost hundreds of millions of dollars has become increasingly hard to get.

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“There is a lot of uncertainty about how much profit gas plants can make year to year,” said Travis Miller, an energy and utilities equity strategist at Morningstar Securities Research. “Investors typically don’t want to finance projects when they don’t have confidence the project can produce steady cash flows.”

The companies, meanwhile, have not just slowed or stopped investing in generation. They have sold off and shut down power plants to refocus on businesses with higher profit margins, such as retail electricity. NRG, for example, launched a three-year plan in 2017 to shrink its holdings in power generation and grow its retail business.

NRG divested some $4 billion in generating and other assets, including $1.3 billion in renewable energy, and embarked on a buying spree of retail electricity providers to become one of the nation’s biggest power retailers. In Texas, NRG probably holds at least 40 percent of the retail electricity market, following its $3.6 billion acquisition of Direct Energy in January, according to a 2018 investor presentation.

NRG began the shift from power generation as early as 2009 with its acquisition of Reliant Energy, the Houston retail electricity provider, and accelerating it after NRG lost some $6.4 billion in 2015 and $891 million in 2016.

Wall Street has embraced NRG’s decision to shrink its power generation business, pushing its stock from a low of about $11 a share in 2016 to more than $40 a share today. NRG declined to comment.

Texas market

Economic conditions have challenged power generators across the country as the higher costs of coal and natural gas compete against the falling costs of wind and solar energy. Perhaps nowhere has it been as challenging as in Texas, where massive amounts of wind-generated electricity can drive wholesale prices into negative numbers — in other words, producers pay buyers to take their power.

Unlike other deregulated markets that pay generators to keep plants ready to meet peak demand — whether they operate or not — prices provide the only incentives for companies to invest in building, maintaining and upgrading power plants.

Texas regulators have responded to generators’ complaints that they were not earning enough to make these investments by raising prices, doubling the maximum to $9,000 from $4,500 about a decade ago, and, in 2019, adopting price adders that allow generators to earn more when power supplies get short.

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That has made power generation largely a seasonal business in Texas, depending on a few weeks of hot weather and high prices to earn profits. The difference of several degrees in summer temperatures can mean the difference between profit and loss, analysts said.

Those risks have soured investors looking for more reliable returns and put pressure on companies to deliver earnings to shareholders rather than reinvesting them in generation, analysts said.

“It is very uncertain what return will deliver from one summer to the next,” said Steve Piper, research director at S&P Global Market Intelligence. “It's not hard to make a case that these are better uses of the capital than putting it into the power plants where the return might not be there.”

The pressure from Wall Street to deliver returns led the Houston company Calpine, the nation’s biggest natural-gas generator of electricity, to sell itself in March 2018 to a consortium of investors led by the New Jersey private equity firm Energy Capital Partners and become a private company.

Before going private, Calpine struggled with lackluster earnings and falling stock prices. In the year before its sale, the company lost $339 million in 2017 while its stock price fell below $10 share, down from about $24 a share in 2014. Calpine declined to comment.

“It has become clear over the last 10 years or so that Wall Street has been a little less interested in companies with wholesale (power market) exposure,” Piper said. “This is certainly true for power plants within ERCOT. Their market mechanism doesn't really deliver a reliable return to new generation.”

Changing economics

The rise of renewable energy has also eroded the weather-based business model on which generators have depended. The peak pricing on scorching summer afternoons in Texas occurs less frequently as wind and solar power generate more electricity to meet the soaring demand.

Last summer, the state avoided the power shortages and spiking prices of the summer of 2019 in part because Texas wind farms were able to produce more electricity during hot spells to meet the demand. Wholesale prices for 2020 topped out at $1,700 per megawatt hour on the afternoon of Aug. 15, far below the state maximum of $9,000 reached during several days the previous summer.

The expansion of solar power could further cut into the peak pricing periods on which generators have relied. Solar produces the most electricity on hot, sunny afternoons when power is needed most.

Solar still represents a tiny share of the state's generation, but it is growing quickly. Solar generating capacity has more than doubled to nearly 6,800 megawatts since the end of 2018 and is projected to more than double again to some 15,000 megawatts by 2022.

In the last 13 years, the generation mix on Texas’ power grid has shifted toward natural gas and renewables, with wind making the greatest gains. Wind energy generates about 20 percent of the state’s electricity, up from just 2 percent in 2008, while the share for natural gas rose to 47 percent from 45 percent, according to ERCOT.

Those gains came mostly at the expense of coal, whose share of generation fell to 20 percent from 38 percent during that period, according to ERCOT.

Vistra Energy, parent company of the generator Luminant and retail electricity provider TXU, cited competition from lower cost renewables and natural gas in 2018 when it shuttered three of the state's largest coal plants, retiring a combined generation capacity of more than 4,000 megawatts and eliminating about 850 jobs.

Vistra, like NRG, has shifted its focus to retail electricity, which its CEO Curt Morgan described in 2019 as “the biggest opportunity” for the company’s investments. Vistra acquired retail electric companies Crius Energy and Ambit Energy in 2019 and Infinite Energy and Veterans Energy in 2020.

Analysts estimate that Vistra and NRG control about 70 percent of the Texas retail electricity market. Vistra did not respond to requests for comment.

Tough environment

Vistra also has moved to capitalize on the growth in renewables. It followed up on a 10-megawatt battery storage unit in Upton County in West Texas that began operating in 2018 with a 300-megawatt lithium-ion battery storage system at its Moss Landing power plant site in California.

The company has three additional battery projects in California and Texas set to come online by 2022.

“There is so much renewable energy now in Texas,” said Miller, of Morningstar. “It really makes the operating environment tough, for natural gas generators, in particular.”

marcy.deluna@chron.com

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