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Subject: Shares of Independent Power Producers and Traders Fall

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April 4, 2002



Shares of Independent Power 
Producers and Traders Fall 




By Robert C. Bellemare
Vice President 


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[News item from Reuters] Renewed concerns over accounting irregularities and heavy debt burdens took their toll on the power sector on Wednesday, sending shares of independent producers and traders falling. The downturn was triggered by disclosures in The Wall Street Journal (WSJ) of a financing arrangement used by Dynegy Inc. (NYSE: DYN) which prompted unwelcome comparisons to Enron as well as an inquiry by the Securities and Exchange Commission (SEC) into energy trader and pipeline operator Williams Cos. (NYSE: WMB). 

Analysis: Just when the market conditions appeared to be stabilizing for the recently hard-hit independent power producers (IPPs), more unwanted bad news has once again plagued this sector. In addition to Dynegy and Williams, companies such as Calpine, Mirant and AES have had significant news in the past week as the companies make moves to weather the storm of business losses, lowered credit ratings, softening energy commodity prices, and questions of accounting practices. Let's take a look at the latest developments for these companies. 

Dynegy shares closed at $28.79 per share, down by about 4 percent, as the market reacted to a WSJ article concerning Dynegy's use of off-balance-sheet transactions designed to cut tax bills and address a growing gap between cash flow and net income. Project Alpha, as it was called, was blessed by Dynegy's former auditor, Andersen, and current auditor PricewaterhouseCoopers. Dynegy was quick to try and distinguish this transaction from the type of business practices that Enron engaged in. Dynegy spokesman John Sousa emphasized, "The primary drivers of this transaction were that it provided us with a long-term source of physical gas supply and a significant tax benefit." Sousa also pointed out that no related parties were involved, Dynegy stock was not used to back the loans, and the transaction was disclosed in Dynegy's financial reports last year. In 2000 the company reported "unrealized gains" of $354 million generated by valuing derivative contracts, increasing the gap between its profit and cash flow. Trading companies include the estimated value for "derivative" contracts they use for future buying and selling of commodities in net income as "unrealized gains." A special purpose entity (SPE) was formed in April of last year with a $300-million loan from Citigroup Inc. The SPE entered into gas trades with a partnership called DMT Supply LP, in which Dynegy held a stake. According to Dynegy, during the first nine months of operation, DMT bought gas from the entity at below-market prices and resold the gas at a profit. But during future years of the project scheduled to end in 2006, DMT will buy gas at above-market gas prices, generating unrealized losses. By arranging transactions in this manner, Dynegy was able to lower its 2001 tax bill by $80 million. But according to WSJ, higher values were being assigned to derivative contracts than those assigned to cash transactions which creates a "disconnect" between reported net income and cash flow that investors could notice. 

Williams shares also dropped by 4.5 percent on Wednesday to close at $23.08 per share on news from WSJ, which reported that the SEC is looking into the company's third-quarter results. In reaction, Williams clarified that it had received a request in early February from the SEC for additional information concerning the company's 2001 third-quarter results but was told after a review that no financial adjustments were needed. Williams' spokesperson Jim Gipson said, "We received an informal, confidential request for information by the SEC in early February about our third-quarter 10Q. They asked a couple of questions, we responded in writing, they called back in seven days and said no amendment to the third-quarter results was required." Gipson emphasized that, "We are not aware of any unresolved or open issues at the SEC." Williams reported a third-quarter net income of $221.3 million, up from $176.5 million, or 27 cents a share, earned in the same quarter one year ago. The quarter included a one-time charge of $71 million for the company's investment in former subsidiary Williams Communications Group. On March 7, Williams announced it had taken a $2.1-billion charge in the fourth quarter to account for its contingent liability on Williams Communications. Williams reported a loss of $477.7 million for the fourth quarter. 

Calpine shares were down 6.26 percent yesterday apparently in reaction to news that Moody's had downgraded Calpine's unsecured debt from Ba1 to B1, along with a negative ratings outlook. Approximately $12.4 billion of long-term debt instruments are affected. This follows a March 29 report, when the company disclosed that it will restate 2001 earnings after the company discovered that emission-reduction credits it had purchased last year were not actually available. In a press release, Calpine said 2001 earnings would be lowered by $11.5 million after tax from the $659.6 million reported on Jan. 31. The restatement will drop 2001 diluted earnings per share after extraordinary items by 3 cents a share, to $1.87. 

Moody's sited several reasons for the ratings downgrades including Calpine's high leverage, limited financial flexibility, and substantial ongoing capital expenditure requirements to complete its reduced build-out program. Calpine's debt is expected to grow over the coming year as the company continues its development of committed projects. While Calpine's total electric sales are expected to increase as it completes additional plants, it is expected to be selling into unfavorable market conditions. Moody's anticipated that lower spark spreads (the difference between electric and fuel prices) will lower in the near term. Moody's warned that the negative outlook reflects the possibility of additional downgrades should Calpine's liquidity position further deteriorate or its cash flow fall below expectations. Calpine plans to fund completion of 22 gas-fired power projects and 2 project expansions during 2002 and 2003. Moody's also assigned a Ba3 rating to Calpine's $2 billion of senior secured credit facilities. According to Moody's, the Ba3 rating reflects the benefits and limitations of Calpine's collateral package. A portion of the collateral package consists of Calpine's equity interests in Saltend and nine U.S. power plants. A principal part of the collateral package is Calpine's natural-gas properties, which may be subject to fluctuation in value based on changes in reserves and gas prices. Moody's claims a portion of these gas reserves is not proven. 

Mirant also continues to experience hard times. Its shares were down 6.21 percent to close at $13.60 per share. Although yesterday's downturn may have largely been driven by the overall downturn in the sector, Mirant has been involved in several interesting announcements this week as it continues to try to shore up its balance sheet. On April 1 it was reported that Mirant has put its Kogan Creek power station and Wilkie Creel coal mine in Queensland up for sale. Queensland's government-owned CS Energy, currently 40-percent owner of Kogan Creek, is reported to be a potential buyer, as are MIM and Macarthur Coal. In a separate transaction announced on March 27, Cleco agreed to buy Mirant's 50-percent interest in a 725-megawatt power plant the companies are building in northeastern Louisiana. The merchant power plant is owned by a joint venture between the two companies. Cleco said it would assume Mirant's $19.5-million equity commitment and pay $48 million to retire Mirant's project debt. Cleco said it would finance the buyout with a combination of new common stock and debt. 

AES has also fallen on tough times. Although the company's stock was up yesterday to close at $8.96 per share, the company continues to struggle. Early this week, AES sent a shockwave through the U.K. market when it announced its decision to put its 363 MW Fifoots Point coal-fired power plant located in Wales into receivership. The recommissioning of Fifoots in late-1999 was funded with a $214.5-million loan arranged and underwritten by Deutsche Bank. Richard Hill, joint administrative receiver at KPMG in London, who is charged with selling the asset, says Fifoots has some GBP80 million of non-recourse bank debt obligations as well as other liabilities that have yet to be fully determined. Similar to the U.S. market, wholesale prices in the U.K. reportedly have collapsed by 30 percent after the launch of last spring's new bilateral trading system. Accordingly, one report claims at least a dozen project loans are either in technical default, have broken their covenants, or are very close to not meeting their coverage ratio. 

In other AES-related news this week it was announced that GE would be purchasing AESGener's 40-percent stake in the Servicios Integrales de Generacion de Energia Electrica (Sigen) services company for an undisclosed amount. GE already owned 60 percent of the joint venture. AESGener, controlled by AES, posted losses of Pesos $5,027mil in 2001 compared to a profit of Pesos $2,275mil in 2000. Operating results were down by 12.5 percent to Pesos $70,241mil on sales declining 23.8 percent to Pesos $347,009mil. The performance of AES' Argentinean subsidiaries TermoAndes and InterAndes, and selling off the subsidiaries Central Puerto and Puerto Ventanas imposed losses. Recently appointed AESGener Chairman Roberto Morgan commented that the company will continue to divest in non-electric assets and assets not based in Chile. 

The fallout of the Enron debacle, lowered credit ratings, and weak commodity prices are providing a 1-2-3 blow that has many energy companies on the ropes struggling to make the bell. The companies are aggressively working to put up a defense by shoring up their balance sheets through asset sales, postponing or canceling projects and taking necessary write-offs. But as quickly as these companies' fortunes have nosedived, they can rise once again. Such is the fickle nature of the commodity world. 


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