When Financial Director interviewed Paul Marsh, former FD and now COO of TXU Europe, some months back, Marsh used the analogy of a three-legged stool to describe his company’s business strategy. The legs were retail customers, virtual and actual generating assets and energy dealing.
The point of the analogy was that the three legs were mutually supporting, each helping to hold up and balance the others.
The recent sale by TXU Europe of its retail customer base and generating capacity to Powergen has turned that strategy into a one-legged stool – and that’s about as bust as you get.
So what broke TXU? There are various answers and two spring to mind.
Firstly, TXU Europe’s Texas parent, threatened with having its own credit rating cut, backed away from underwriting a $750m TXU Europe line of credit, leaving its European subsidiary to fend for itself.
Secondly, the cataclysmic 40% drop in UK wholesale energy prices since the New Energy Trading Arrangements (NETA) appeared on the scene has seen the company nailed to very long forward contracts at ridiculous prices.
This meant that it was facing a loss of anything from £7 to £12 on every megawatt of electricity it sold to customers.
As Jason Steed, senior utilities analyst with HSBC notes, with the UK market unlikely to see any major price improvements for at least the next two-to-three years, that left TXU Europe in a very deep hole indeed.
However, Eric Anstee, of Anstee Associates, formerly FD of Eastern Electricity, the company that Texas TXU bought to create TXU Europe, points out that there are still a number of questions to be asked about the management strategy that created the hole in the first place.
“John Devaney, the former CEO of Eastern, and I, worked hard to acquire some serious generating capacity for Eastern before TXU came along. We spent about £2bn in a complex lease-back deal that meant that the four generating plants we bought from Powergen and National Power made money for the company from day one. This was then matched off against the price we charged customers and we ran a balanced book. Wholesale prices might have crashed, but domestic tariffs have not reduced. If things had been managed properly, TXU Europe might have seen decreased profitability, but they shouldn’t have gone bust,” he comments.
“However, TXU sold off the assets and said that the modern way was to have virtual power stations with forward contracts. I told Financial Director back in May that I believed that this strategy would destroy, rather than create value, and it seems to have done so much faster than even I anticipated,” Anstee said
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Hindsight, of course, is a wonderful thing. But looking back one has to ask if it was sensible for TXU Europe’s management team to agree to buy, for example, 60% of the output of the UK’s largest generator, Drax, for 10 years or so ahead, at what now looks like stellar pricing.
As TXU Europe spokesperson Chris Judge notes, the plain fact is that the wholesale price then went to hell, and the company’s Texas parent went back to Texas, taking TXU Europe’s ball with it. Neither of these events were exactly foreseen by management.
But still, shouldn’t they have at least asked themselves if they were not, perhaps, at the top of a bull market in energy? Isn’t this what risk management is all about? The company’s contract with Scottish and Southern is reputed to be a 12-to 14-year contract. Again, a good way of burying yourself if the wholesale price goes south.
There are, of course, extenuating circumstances. As HSBC’s Jason Steed points out, it was very difficult in 1998 and 1999 to foresee just how swiftly the UK duopoloy of National Power and Powergen would fragment and dilute, creating virtually perfect competition in a market that has about 25% over capacity. He notes that “not even the most bearish industry player thought that the price per megawatt-hour would drop in two years to where it is today (around £13 to £15)”.
Moreover, the government has tweaked the original privatisation model. The introduction of NETA has done wonders for the consumer, but it has left the industry with no long-term pricing framework and no long-term pricing signals. This is not good for future investment in generating plant.
As Anstee says, “government has changed the rules and wrong footed management. The original privatisation rules had a capacity payment element to ensure that capacity was there. It was a very safe, well thought through model. This has now gone and subsequent tampering with the model has created a very dangerous strategy for the long term. The lack of incentive to maintain capacity could yet cause California-style price spikes and brownouts in the UK if we have an unexpectedly cold winter.” The cold front could therefore spread well beyond TXU.