TXU's Imminent Bankruptcy Reveals Deregulation's Failure

September 11, 2013
Loren Steffy

The largest buyout in history is about to give way to one of the largest bankruptcies. The parent of power retailer TXU Energy and generator Luminant may run out of money by year's end, triggering bankruptcy, Moody's predicted in a report this week. The 2007 buyout of what was then TXU saddled the company with some $40 billion in debt, a pile of leverage so mountainous that the company has never been able to dig itself out. At the time, the private equity firms leading the deal, Kohlberg Kravis Roberts & Co., TPG Capital and Goldman Sachs envisioned fat profits from Texas' allegedly deregulated electricity market.

One of the firms, TPG, had already made some fast cash in 2004 by snapping up generating assets in the Houston area for $3.7 billion before flipping them to NRG Energy a year later for a cool $5.8 billion. Of course, that deal grew out of the break up of Houston's regulated utility, and ratepayers essentially subsidized TPG's profits by eating the "stranded costs" tied to the generating assets. It's part of the reason that the Houston area has had some of the highest electricity rates in the country during much of Texas' deregulation experiment.

TPG's Houston gambit paid off because Texas' deregulation law essentially tied the wholesale price for electricity to the price of natural gas. Many of the Houston-area plants were coal-fired, and at the time, coal was a cheaper fuel. As a result, the plants came with a built-in profit from the spread between gas and coal.

The buyout boys hoped to use the same strategy on the TXU deal, but their timing was less fortuitous. The recession cut electricity demand and the rise of hydraulic fracturing unleashed a glut of natural gas that caused prices to tumble. Suddenly, coal had no cost advantage, which meant TXU was left to the mercies of the deregulated market.

(Don't worry too much about the buyout boys. Their investment may be in the tank, but they managed to siphon off some hefty fees along the way.)

In Texas, the market offers little incentive for generators to build new capacity, and the state has limped along for the past few summers under the threat of rolling blackouts. This summer, with generating reserve margins at their narrowest since deregulation began, the air conditioning kept running mostly because temperatures were cooler than expected. Without consistent higher prices, generators have no incentive to build new power plants, and given TXU's crushing debt, it can't afford to borrow. To make matters worse, retailers compete for customers on contracts of a year or less, which means generators can't get the long-term revenue commitments they need to finance new plant construction.

As a result, generators, allegedly proponents of deregulation, have asked the state's Public Utilities Commission to intervene. Regulators, in fact, have increasingly meddled in the wholesale market, making further mockery of the notion that the Texas system is in any way free.

Meanwhile, the retail business remains a miserable after-thought of deregulation. In the decade since the state implemented consumer choice, customers have been  more upset about higher bills than concerned with picking electricity providers. The only product differentiation is in the contract terms, and for most customers, the modest savings isn’t worth the effort of wading through the fine print. At the same time, the retailers themselvesare struggling with razor-thin margins. Those without generating assets survive on their hedging abilities, which grows more difficult as liquidity has left the market in recent years.

TXU's looming bankruptcy casts even more uncertainty onto an already bleak market outlook. Moody's MCO +0.96% predicted that the bankruptcy would have "no material impact on the grid," but that's because it already has. The grid is weaker and most Texans are paying more for less reliability. Meanwhile, the state's utility regulators are doing everything they can to prop up wholesale prices in an attempt to appease generators, while still arguing that the market is deregulated.

Against the broader utility industry trends of declining consumption and rising costs, TXU's imminent bankruptcy is a testament to the failure of Texas' deregulation experiment.

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