The Federal Energy Regulatory Commission's recent denial of WayzataOpportunities Fund II's bid to acquire a 1,054-MW natural gas-fired plant inTonopah, Arizona, from MACH Gen sent a ripple of concern through the powersector, particularly among players in the secondary market.
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The significance of FERC's decision could be tested this year when FERCreviews potential market power issues involved in Dynegy's plannedacquisition of Ameren's merchant generation assets, announced March 14.
It could be a real stumbling block, UBS analyst Julien Dumoulin-Smith said.It is unclear if there will be a mandated mitigation plan or forceddivestitures, but "it is a key approval, and they are the two biggestgenerators in Illinois."
FERC's denial of the Wayzata deal was based on its analysis that theapplicants failed to prove the acquisition would not have an adverse effecton competition, and it marked "a rare instance" of the commission rejecting apower plant sale under Section 203 of the Federal Power Act, NatashaGianvecchio, a partner in Latham & Watkins? finance department.
In the filing, the applicants -- Saddle Mountain Power, the Wayzatasubsidiary that would actually purchase the plant; MACH Gen; and NewHarquahala Generating, the MACH Gen subsidiary that owns the plant --acknowledged that, using the Herfindahl-Hirschman Index test, the acquisitionwould result in market concentration in seven of 10 instances, with marketshares ranging from as high as 69% in the available economic capacity screento 29% in the economic capacity screen.
From a market power perspective, the problem was that the acquisition wouldgive Wayzata, through another one of its funds and the common fund manager,two large plants in the Arizona Public Service balancing authority area.
Wayzata, through Sundevil Power Holdings, owns 50% of the 2,300-MW Gila Rivernatural gas-fired plant in Gila Bend, Arizona. Entegra Power Group owns theother half of the plant.
To remedy the market power issues, the applicants proposed a plan to mitigatethe potential anticompetitive effect of the acquisition. The mitigation plancalled for the dispatch authority for the plant to be handed over to a thirdparty, Twin Eagle Resource Management.
Despite the applicants? efforts, FERC found that the energy managementagreement with Twin Eagle did not switch control of the plant because Wayzatawould still set the plant's operating limits, dispatch and efficiency curves,and operating costs, and Twin Eagle would have to follow "a detailed,proscribed methodology for dispatching the Harquahala Facility, from whichmethodology it has little discretion to deviate."
FERC also noted that both the Gila River and Harquahala plants use similartechnology and that under competitive conditions they would have similardispatch costs and could be available at a similar point on the supply curve.
Under those circumstances the regulator said that "overt cooperation" betweenSundevil and Twin Eagle would not be required for the Gila River plant to bedispatched in an anticompetitive fashion.
And, finally, FERC noted that New Harquahala would have the right to enterinto long-term power purchase agreements and would retain responsibility foroperations and maintenance.
On that basis, FERC denied the applicants' Section 203 request, but withoutprejudice, meaning that they could refile, presumably with an amendedmitigation plan.
One possibility that might have a better chance of passing FERC scrutinywould be to line up a long-term contract to sell the electrical output fromthe plant, but long-term contracts have become hard to come by because loadserving entities are reluctant to lock in prices in the current environment.
Calls to MACH Gen and Wayzata for comment were not returned by press time.
MACH Gen is owned by several investment firms, including Strategic ValuePartners. Rockland Capital holds MACH Gen's debt.
FERC's denial caught the industry's attention. "The decision is significantbecause it is unusual for FERC to issue an outright rejection of a 203application," Stephen Hug, an attorney with Bracewell Giulliani, said.
Among other things, he said, the decision highlights the difficulty faced byan applicant for an asset that operates outside an organized wholesale market.
"I can?t think of another recent instance of a Section 203 denial forgeneration assets not involving a vertically integrated utility," Gianvecchiosaid.
There is a sense now that FERC's scrutiny of Section 203 applications will beless of a "check the box approach," she said. The decision could signal amore comprehensive or holistic approach to Section 203 filings on FERC's part.
Under that approach, energy management agreements alone may not be sufficientto demonstrate that control of a plant has been relinquished and, conversely,retaining the ability to enter into long-term contracts may be deemed as anindication of control for Section 203 purposes.
One executive at a private equity firm, who requested anonymity, said he doesnot expect FERC's decision to cast a pall on the secondary market. He saidthe decision was unfortunate for Harquahala, but that it seems to be aone-off situation, not a trend.
Another private equity player, who also requested anonymity, questionedwhether the applicants would be able to fix the mitigation plan, but saidthere are plenty of other players that could step in if Wayzata does notrefile.
Each letter of the MACH Gen's first name stands for a power plant that thecompany took over after PG&E National Energy Group, the original developer,defaulted on the projects.
Those plants, which all entered service between 2001 and 2003, are the 360-MWMillennium station in Charlton, Massachusetts, the 1,323-MW Athens plant inAthens, New York, the 1,176-MW Covert facility in Covert, Michigan, and NewHarquahala in Arizona.
The Covert plant was bought by Tenaska Capital Management in 2008.
--Peter Maloney, firstname.lastname@example.org