TXU takeover has a strong green cast

1 April 2007


TXU Corp tentatively approved on February 26 a $45bn takeover led by private equity firms Kohlberg Kravis Roberts & Co and Texas Pacific. It is expected that the transaction will be closed later this year, subject to the approval of shareholders and regulators including the Federal Energy Regulatory Commission and the Nuclear Regulatory Commission. A significant announcement made in connection with the merger agreement was that TXU’s previous plan for the construction of eleven coal fuelled plants would be scaled down to three.

KKR and TPG plan to spend $5bn on the takeover, while a consortium of investor banks will provide $3.5bn. The remaining funds are to be borrowed.

Under the terms of the merger agreement, TXU may solicit proposals from third parties during the 50 days following the announcement. It is expected that the deal will be given approval, owing in part to the equity groups’ decision to invite green groups Environmental Defense and the Natural Resources Defense Council to play an active role in negotiations regarding the company’s environmental commitments following the deal.

Immediately following the takeover announcement, TXU’s share price rose by almost $10 to over $70. Under the bid terms, shareholders will receive $69.25 per share, representing a 15% premium. The investor group will assume more than $12bn of debts. KKR has confirmed that it is “committed to hold… [its] ownership interest in TXU for more than five years... [and has] no intention to spin-off or sell any of the businesses”.

Following the formation of the private company, three independently operated businesses will be formed in a reorganisation. The generation arm will be known as Luminant Energy, Oncor Electric Delivery will replace TXU Electric Delivery, and TXU Energy will retain its name as the company’s retail arm. Until the transaction is completed, Texas Energy Future (TEF) will remain as the holding company formed by the takeover.

Cancelled coal plants

TXU’s decision to cancel plans for the construction of eight of its previously planned coal plants represents a 75% reduction in new coal capacity. The company states that the suspended permit applications were for supercritical plants with unit capacities of 858 MW, which would have been built over 4 years at a cost of approximately $1100/kW.

The three remaining orders will be continued in light of the state’s immediate additional capacity requirement estimated by the electricity reliability council of Texas (ERCOT), which in 2006 made a significant revision to its ‘annual reserve report’, by increasing Texas’ expected economic growth and future power demand. This pushed projections for the reserve margin percentage (the difference between the peak load forecast and the available generation capacity) below the ‘safe’ level of 12.5%, to 11.4% in 2008, 8.5% in 2009 and 7.2% in 2010. It is forecast that a further 10 GW of capacity will be needed to meet the state’s growing demand.

Of the three remaining orders, two, at Oak Grove, east of Dallas, are to be 817 MW supercritical plants using older GE turbines “reworked and modernised for use”. One, a new unit for Sandow, near Rockdale, the fifth unit on the site, is to employ fluidised bed technology with subcritical steam conditions. Alstom will be supplying the turbine. TXU forecasts that construction of the Oak Grove plants should be completed in 2009/10 if the permit is approved by the Commission for Environmental Quality later this year. At the end of February the court for the western district of Texas approved the consent decree for the new 581 MW Sandow unit 5 facility. Construction is expected to be completed in mid 2009.

The financial impact of terminating the eight fixed price purchase orders could, according to TXU, result in “the impairment of the $900m of capital costs... [in addition to] future penalties and costs associated with equipment order cancellation and other suspension activities estimated to total up to $200m.” However, this total of £1.1bn may be “subject to potential recovery or salvage amounts, which [at present] cannot be estimated...”.

A greener agenda

The cancellation of the plants, which is estimated to result in the prevention of 56 m tonnes of CO2 equivalent per year, forms part of TEF’s aspiration to eventually join the United States Climate Action Partnership (USCAP), whose call for a mandatory cap on carbon emissions, it is pledging to support. The company plans to reduce mercury, SO2 and NOx emissions by 20% compared to 2005 levels, and cut its own carbon emissions to near-1990 levels (67 tonnes of CO2), through 2% efficiency gains, and the installation of new emissions controls, at all existing and new plants.

While the announcement to focus on cleaner generation has been applauded by environmental groups – especially given the fact that Texas emits 700m tonnes of CO2 per year, more than any other US state – the cancellation of approximately 7 000 MW of capacity presents a different challenge, that is, how the state will deal with the growing power demand.

TEF announced in March that it has begun planning for two IGCC demonstration plants as part of its “commitment to exploring... [the technology’s] potential to [help] meet Texas’ reliability requirements.” The company is currently considering proposals concerning a number of competing IGCC technologies, which it may deploy at existing sites originally reserved for the cancelled pulverised coal plants. One of the new facilities will use PRB coal, whilst the other will be fired with lignite coal. The company also intends to explore flue gas and algae carbon capture technologies.

In addition to the reduction in coal plant construction, TEF plans to achieve “more than $300 million in annual savings through a 10% price reduction for residential customers... who have not already selected one of TXU Energy’s other lower priced offers.” A 6% reduction came into effect in March, with the other 4% to be applied at the close of the merger.

The company has also planned a $400m investment in a demand reduction programme aimed at focussing on conservation and energy efficiency policies over a five year period. Additionally during this period, the company plans to increase its wind power capacity to 1.5 GW, and introduce solar/photovoltaic rebates for customers. Although no formal application has yet been made, TEF also intends to join the FutureGen Alliance, the non-profit public-private partnership working towards the design of a near-zero emissions coal-fuelled power plant.

• TXU plans to file applications for combined construction and operating licences for new nuclear generation capacity, and has selected Mitsubishi Heavy Industries’ US-APWR reactor technology. The company is considering the construction of two reactors with an expected combined capacity of 3 200 MW at its existing two-unit Comanche Peak site, as well as at numerous greenfield sites. The applications for licenses at these sites are likely to be made by October 2008, and would facilitate commercial operation from 2015 to 2020. TXU recently notified the US nuclear regulatory commission of its reactor selection.

Stop press: It was reported at the time of going to press that KKR and TPG could pull out of the takeover owing to the possible imposition of pending regulations which it sees as a barrier to the sale. The Blackstone Group, together with The Carlyle Group and Riverstone Holdings, are said to be considering a rival bid.

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