Famed Texas Energy Takeover Runs into Heavy Weather

In fall 2007, the world's most accomplished practitioner of the leveraged buyout and corporate reorganization, K.K.R., engineered the biggest private equity takeover in history, buying TXU, the top Texas electricity company. What made the deal especially newsworthy was that K.K.R.'s Henry Kravis formulated it in close collaboration with Fred Krupp, the highly paid and hugely influential CEO of Environmental Defense (now once again the Environmental Defense Fund), as well as leaders of the Natural Resources Defense Council. The executives of EDF and NRDC, arguably the two most technically expert and politcally sophisticated environmental advocacy organizations in the United States, obtained from K.K.R. and TXU a commitment to ditch plans for 8 of 11 coal-fired power plants.

Writing in this space not long after, Spectrum editor-in-chief Susan Hassler raised some pertinent questions: Was the deal as green as it looked? Might the coal plants have been scuttled anyway? Assuming the new coal plants were actually needed, where then would Texas find alternative generation? Would those sources be as green as promised? Hassler quoted one analyst as saying that while the deal showed that climate change had emerged as a big factor in electricity planning, it might also have "provided TXU an escape strategy from its ill-fated plan to build 11 new coal plants in Texas."

At the time nobody seemed to wonder whether the plan was financially sound, probably because it was concocted by one of Wall Street's favorite wizards, with the support of an environmental leader who makes a point of matching the lifestyles of the CEOs he negotiates with. But in a long analytic article that appeared in the business section of last Sunday's New York Times, reporters Jenny Anderson and Julie Creswell suggest that the deal had a near-fatal flaw: It was in effect "a gargantuan bet that natural gas prices would keep climbing," but instead they plummeted; as a result those who financed $40 billion of the $48 billion deal " have seen losses," with their bonds trading at 70 or 80 cents on the dollar.

The Times article, though long, raises as many questions as it answers, and is not always as clear as it might be. Why was the deal a big bet on higher natural gas prices? Because, the authors say, electricity prices in the competitive Texas market are mainly governed by gas prices; thus, if a company like Energy Future Holdings (the former TXU) can generate a lot of electricity using cheap coal, it stands to make big profits if can sell the electricity at prices determined by expensive gas.

But wait a minute: Wasn't TXU supposed to be weaning itself off coal? And didn't it promise, as Hassler reported, to buy a lot more electricity generated by wind? If the company is buying more electricity in the open market, shouldn't it also benefit from lower prices? Which is it?

No mention is made in the New York Times article of nuclear energy. But within months of the K.K.R. takeover and coal plant cancellations, Texas announced plants to invest heavily in nuclear generation. The big Japanese nuclear manufacturers--Hitachi, Toshiba, Mitsubishi--began angling for business. But in the last year Texan nuclear prospects have dimmed markedly, with a San Antonio project hanging in the balance. Could false nuclear expectations have played a part in the 2007 transaction? It would be an interesting question to put to EDF and NRDC leaders, some of whom have turned quietly pro-nuclear because of climate concerns but still hesitate to tell their constituents four-square where they stand.

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