Earlier this week Dynegy announced that it will sell nine of its U.S. power plants to LS Power Associates LP. Dynegy, as with other power producers, has been struggling with decreased electricity demand and prices, and this move will allow them to pay down some of their debt. But as the WSJ reports, reducing the company’s portfolio could limit its earnings potential. More disturbing to me however, was the inference in the article that because the scope of the transaction was limited to gas-fired plants, the remaining coal-fired assets somehow lacked in financial value. 

I wish I had the capital to acquire coal-fired plants at this point in time. Many such plants can generate electricity at $20-$25/mWh and even in the depths of a recession sell it at $35-100/mWh. And as the current recession ends and demand grows, with so many new coal plants having been cancelled, clearly market fundamentals are going to drive power prices even higher.  Add to this currently low natural gas storage levels and the unprecedented levels of shut-in drilling capacity, and I predict we will be seeing locational marginal wholesale power prices in the $60-$200/mWh range.

The combination of these market fundamentals means that existing coal-fired generation will be capable of producing large profit margins in the near-future, even if federal cap and trade legislation for CO2 is passed and allowance prices rise above $25/ton. And we should not forget that with the great bulk of the initial CO2 allowances being expected to be allocated to power generators as opposed to auctioned, this means whatever the market price of allowances, only a small portion of those prices will be borne by generators.  While the value of decreasing CO2 will reflect market allowance prices, these same prices will have only a relatively small impact on existing generating costs.  

All of this suggests the Oracle of Omaha (Warren Buffet) knows what he is doing in his recent large-scale acquisitions of coal fired-generation. It would be nice to have a few billion dollars in extra capital sloshing around so I could follow suit. But that is obviously wishful thinking.

Back to thinking about my day job – the basic economic principles and market developments described above mean one thing for sure: every MW of capacity gained, Btu of heat rate saved and pound of emissions reduced is going to add to the profitability of our existing fossil generating assets. These assets are going to be ever more valuable as normal economic conditions return and the legacy of all the cancelled new plants manifests in what economists refer to as scarcity and associated rents.