Outlook Darker Than Ever for Texas's Energy Future Holdings

In fall 2007, in one of the biggest leveraged buyouts in history, the famed takeover specialists KKR took control of the Texas utility TXU, promising to cancel all but three of eleven planned coal-fired plants and find greener, alternative energy. Involved was a stellar cast of negotiators, facilitators and investors, including former president George H.W. Bush's right-hand man James Baker, the sage of Omaha Warren Buffett, and the very influential and highly remunerated CEO of the Environmental Defense Fund, Fred Krupp.

Now Buffett is calling his investment in TXU, renamed Energy Future Holdings, a "major unforced error."

Even at the time of its closure, however, the deal raised serious questions. IEEE Spectrum editor Susan Hassler wondered whether the deal was as green as advertised, where the replacement energy would come from, and whether professed concerns about climate change might be just a cover to get out of investment commitments that were looking spurious. Soon, TXU disclosed plans for an ambitious program of nuclear construction, which may have been a surprise to some of Krupp's constituents.

By early 2010 it was apparent that another factor was eroding the foundation of the deal, namely plummeting natural gas prices. The main message here is that the revolution in unconventional gas—hydraulic fracturing or "gas fracking"—is proving to be a "disruptive technology" in every possible way. But why is it turning out to be so disruptive to the fortunes of Energy Future Holdings, and why did so many brilliant people not see the iceberg coming?

Ultra-low natural gas prices are increasingly a nightmare for all developers of innovative energy technologies. Yet at the same time, paradoxically, they are a blessing from the perspective of climate change policy: The very parties that have fought hardest against putting a price on carbon, the utilities that rely heavily on coal to make electricity, are now switching to gas-fired generation, keeping U.S. greenhouse gas emissions markedly lower than they otherwise would be.

Seen in the narrower perspective of a profit-maximizing investor-owned utility, surveying prospects at the end of 2007 when gas prices were relatively high, if you happened to be relying mainly on paid-for coal plants that produced inexpensive electricity, then you stood to reap big rewards if you could sell that cheap energy into markets in which the marginal cost of electricity was governed by the higher cost of natural gas. That evidently was the fundamental premise of the TXU takeover.

"The [TXU] deal was announced and closed at $8 gas [per million British thermal units] and now here we are at $3 gas,” an analyst told the Financial Times [subscription required] this week. “The majority of the earnings power is from generation assets and they are inherently long natural gas. Those prices just did not work out for them and the reason is fracking."

But why, considering that the revolution in unconventional gas began in Texas's Barnett Shale [red area in map] , did the luminaries examining the prospective TXU deal not see the possibility of a long-term decline in natural gas prices? Nobody knows or nobody's saying, but it's a clear warning to anybody who thinks they know for sure the world's energy future—even its near future.