Calpine's exit from BK doesn't mean that they are out of the woods

Implications: The analysis of recent press releases implies that Calpine has valuable assets in CA and TX whose value will somehow become realized in the coming years due to scarcity of low-carbon generating assets. However, the presumed scarcity of generating assets in CA and TX have been widely forecasted the last five years but never appeared.  Why should they materialize now? The right answer is that they probably will NOT materialize.  This generator will be forced by the in-state utilities to liquidate its assets--at prices well below replacement cost--by the regulatory pressure that they exert through their public commissions. In a perfect economic world, Calpine's assets would be extremely valuable. But in our actual world, where utilities exert their considerable lobbying power at their respective commission levels, Calpine will be forced to sell their assets at well below their economic value, thereby depriving shareholders of any meaningful return.

Analysis: The analysis on GLG of recent press releases implies that Calpine has valuable assets in CA and TX whose value will somehow become realized in the coming years due to scarcity of low-carbon generating assets.

However, the presumed scarcity of generating assets in CA and TX have been widely forecasted the last five years but never appeared.  Why should they materialize now?

The right answer is that they probably will NOT materialize.  This generator will be forced by the in-state utilities to liquidate its assets--at prices well below replacement cost--by the regulatory pressure that they exert through their public commissions.

In a perfect economic world, Calpine's assets would be extremely valuable.

But in our actual world, where utilities exert their considerable lobbying power at the respective commission levels, Calpine will be forced to sell their assets at well below their economic value, thereby depriving shareholders of any meaningful return.

Why?  Let history be your guide.  If there had been any value to these assets, they would have readily been realized within the BK.  However, most of them are contracted long term at below market prices to cogen hosts and electric utilities who have no motivation to break their contracts.  In fact, they have every incentive to pin Calpine to their terms, and acquire the asset -- through hard bargaining -- to add to their own fleets.

During the BK, Calpine had a golden opportunity to reject all of these contracts, but most of them they continued to honor--for example, the 1000 mw contract with the State of CA that they tried to reject, but ultimately honored, while for 2 years it bled cash from the company.  Having acquiesced to the state to honor the contract, the state withdrew its objections to the BK plan, re-negotiated the contract and allowed them to proceed out of bankruptcy.  But how do you think PG&E feels having 1000 mw of baseload energy at below market prices extracted from their portfolio, that they will have to replace?

Meanwhile, the CPUC is giving CA utilities carte blanche to build their own generation.  These utilties will undoubtedly use this hammer, and their success in acquiring new generation projects from other BK developers at 50 cents on the $ (see Mirant at Antioch), to leverage IPPs such as Calpine out of their assets without market-based compensation.  Remember--utilities and their commissions use cost basis, even if it is 5 years past.

If one were to carefully review Calpine's reorganization plan, one would discover that it is based on spark spread projections for each market.  This is exactly the type of analysis that led Calpine's Bob Kelly to finance, and Pete Cartwright to order the building of, many more plants than their markets could support.  It is the same reason why the re-org plan is basically flawed, but it is the best that the debtholders could come up with to salvage their investments (they don't want to be taking over power plants!).  However, it is the reason that equity holders will still want to avoid this dead cat which hasn't reached its nadir yet.