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Supercharge your portfolio with Orion Power Holdings, Inc.
by Siu-Yee Ng
I was on the phone one evening talking to a salesperson about installing cable at the house. After an excruciating half hour of trying to make this practically illiterate woman understand what I wanted, it finally came down to scheduling an appointment. There's a four-hour time window where customers have to wait for the cable man — that's what scheduling an appointment means today. Don't these people know that we work? I realized two things. The tight job market is causing companies to hire any Shmoe off the street. And monopolies provide poor customer service.
When I hear deregulation, I see opportunities for investors and consumers alike. After the Telecommunications Act of 1996 opened up competition in the telecommunications industry, consumers benefited from lower prices and investors reaped profits from the companies that emerged.
Well, that's happening now with the U.S. electric power industry as it shifts towards deregulation.
With deregulation, consumers will have a choice and increased competition will inevitably drive prices down.
Total electric generating capacity in the United States is approximately 783,000 megawatts, installed in approximately 3,000 individual facilities with an estimated US$224 billion in retail sales.
The passage of the Energy Policy Act in 1992 significantly expanded the opportunities available to wholesale power generators like Orion Power Holdings, Inc. Under this law, the Federal Energy Regulatory Commission (FERC) requires owners and operators of electric transmission facilities to give wholesale generators and other wholesale market participants access to transmission lines on a non-discriminatory basis. This right enables Orion and other wholesale generators to sell the energy they produce into competitive wholesale energy markets.
The Energy Policy Act also created a new class of generators — exempt wholesale power generators — that are not subject to portions of the regulatory structure otherwise applicable to electric utilities and their holding companies.
In April 1996, FERC adopted Orders No. 888 and 889, providing for nondiscriminatory open-access electric transmission services by public utilities, separate from wholesale electricity sales. This development has opened wholesale power sales to more competition. The U.S. Circuit Court of Appeals for the District of Columbia recently upheld Orders No. 888 and 889 in nearly all respects.
In December 1999, FERC issued Order No. 2000, which encourages and provides the principles for the establishment of a system of regional transmission organizations that would control the transmission facilities within their regions.
More recently, certain states have started to support complete deregulation of the electric generating industry. As of July 2000, 26 states, including New York, Ohio and Pennsylvania, have enacted legislation or issued comprehensive regulatory orders to restructure their electric power industries to promote competition in the wholesale and retail sale of electric power. Similar restructuring is being considered in virtually every other state.
Electric shock
Since 1997, approximately 145,000 megawatts of power generating capacity in the United States have been sold or transferred by regulated electric utilities. According to published sources, up to 70,000 additional megawatts of power generating capacity in the United States will be available for sale or transfer to wholesale power producers by the end of 2002.
As a result of these anticipated divestitures and the need to replace inefficient generating facilities, there exists a significant opportunity for investment in the power generation industry. Orion is acquiring and developing a portfolio of generating facilities in order to operate as a competitive electric generating and wholesale supply company in a deregulated marketplace.
Juicing up
Generating facilities can be categorized according to the way they produce energy for the region they serve. "Base load" facilities are those that provide at least some power at most times and are used to satisfy the base level of demand for power (or "load") that is not dependent upon time of day or weather. "Peaking" facilities are those that satisfy demand for power as it rises during the course of the day or when weather or other conditions increase demand.
Peaking facilities may be divided into several additional tiers, depending on the level of demand for power necessary for them to be required. Some intermediate facilities, although not required all the time, are used to satisfy the first incremental increases in demand above the base level, and are typically needed to satisfy regular daily power demand. Other peaking facilities are not used except on those occasions, such as hot summer days, when power demand reaches annual highs. The various tiers of base load and peaking facilities serving a particular area or region are often referred to as the "generation stack" for that area or region.
Orion's current facilities are weighted towards base load and intermediate units, although the New York City Assets include several peaking units near the top of the New York City generation dispatch stack. The Midwest Assets are predominately base load facilities.
For administrative and energy distribution purposes, the United States and Canada are divided into a number of areas, generally referred to as "power pools" or "reliability regions." In some areas, the role of these power pools in managing the generation and distribution of energy is being taken over by new organizations, known as "independent system operators" (ISOs) and "regional transmission organizations," that will supervise a market-based system for generation and transmission of electric power. FERC oversees the operations of these organizations in the United States.
In many areas, there are physical constraints on the transmission of electricity that require the existence of generation services within a particular region to ensure that customers are supplied with electricity. These regions are referred to as "load pockets." Load pockets that cover large regions may themselves include smaller load pockets. The existence of a load pocket may require selected generating units inside the load pocket to produce electricity, even though less costly sources of electricity exist outside. Currently, Orion's assets serve load pockets in New York City, Pittsburgh and Cleveland. Load pockets can be mitigated with the construction of additional transmission facilities.
More power
Orion owns and operates power plants and sells electricity and a broad range of electricity-related products and services to utilities, municipalities, cooperatives and retail aggregators in the newly deregulated wholesale market.
Orion's growth has come entirely through the acquisition of operating facilities. Substantially all of its revenues will come from facilities acquired in 1999 and 2000 or in the future.
Wholesale power generators like Orion typically sell three types of product: energy, capacity, and ancillary services. Energy refers to the actual electricity generated by their facilities and sold to intermediaries for ultimate transmission and distribution to consumers. Energy is Orion's only product that is subsequently distributed to consumers by power retailers.
Capacity refers to the physical capability of a facility to produce energy. In some regional power markets, like the market managed by the NY ISO, a market for capacity exists apart from the market for the energy produced by that capacity. In other power markets, like the ECAR region in the Midwest, there is no market for capacity as a separate product and the value of the underlying capacity is included in the price of the energy produced.
Buy and sell
In early April 2000, the first auction of capacity in New York City was held by the NY ISO for the summer 2000 capacity season, which runs from May 1, 2000 until October 31, 2000. Orion bid 1,835 megawatts of capacity from its New York City Assets into the auction and was successful in selling all of that capacity at a price of US$105,000 per megawatt year, which is equal to the price cap imposed by regulatory agencies, for a total of approximately US$96.3 million.
Orion has sold all of the output of the Hydro Assets, including energy, capacity, and ancillary services, to Niagara Mohawk Power Corporation on a bilateral basis through September 30, 2001. Under this contract, Orion receives an annual fixed payment totaling US$71.8 million for the period October 1999 through September 2000 and US$73.6 million for the period October 2000 through September 2001, and a variable payment of US$20 per megawatt hour for all generation above approximately 2.2 million megawatt hours.
The actual targets are set on a quarterly basis to reflect seasonal fluctuations in energy production from the Hydro Assets, and payments are made monthly. If Orion fails to meet the minimum generation threshold, it must pay penalties to Niagara Mohawk. The 2.2 million megawatt hour target is approximately 78% of the average generation for the units over the last ten years.
Generation at hydroelectric facilities, however, varies based on precipitation. Due to the drought conditions experienced in the Northeast during the summer of 1999, Orion was short of the minimum threshold for the third and fourth quarters of 1999 by approximately 11%. This resulted in additional net costs of US$1.2 million for the year to meet its obligations (under 2% of its annual fixed payment from the Hydro Assets under the Niagara Mohawk agreement).
Orion has a gas tolling agreement with Constellation Power Source covering the Carr Street Generating Station, which continues until 2003. Under this agreement, Constellation Power Source will have the exclusive right to all energy, capacity and ancillary services produced by the plant. Constellation Power Source will pay for, and be responsible for, all fuel used by the plant. Orion is currently paying approximately US$3.6 million per annum as a fixed fee and US$3.07 per megawatt hour generated; both fees will escalate by approximately 2.5% per annum.
The drawback here for Orion is that periodically it relies on a single supplier for the provision of fuel, water and other services required for operation of a facility. Likewise, at times Orion relies on a single customer or a few customers to purchase all or a significant portion of a facility's output. The failure of any one customer or supplier to fulfill its contractual obligations would negatively affect financial results.
Consequently, Orion's financial performance is dependent on the continued performance by customers and suppliers of their obligations under these long-term agreements and, in particular, on the creditworthiness of Orion's customers and suppliers.
Sparks flying
In April 2000, Orion acquired the Midwest Assets from Duquesne Light Company, and a subsidiary of Constellation Operating Services that was established to perform operations and maintenance services for the Midwest Assets. The Midwest Assets consist of seven power generating facilities, six of which are active, located in western Pennsylvania and Ohio. In an asset swap with FirstEnergy Corp, Duquesne Light Company recently acquired three of the facilities. The other four (including one retired facility) have historically been owned and operated by Duquesne Light Company.
With the acquisition of the Midwest Assets, Orion entered into a provider of last resort contract, giving it the right and obligation for a specific period to supply Duquesne Light Company with the energy to meet Duquesne's obligations as the provider of last resort to its retail customers in the Duquesne Light Company service area, which basically covers the greater Pittsburgh area. Orion recently agreed to extend the period covered by this agreement until December 31, 2004.
The Midwest Assets are located in an operating region known as the East Central Area Reliability Council, more commonly referred to as ECAR. The ECAR region is the second largest region in the United States ranked by energy consumption, with total demand in 1998, the latest year for which figures are available, of nearly 542 million megawatt hours. The ECAR region covers part or all of the following states: Indiana, Kentucky, Maryland, Michigan, Ohio, Pennsylvania, Virginia and West Virginia.
Deregulation in these states is at various stages. Some, like Pennsylvania, are well advanced toward full market-based competition, while others are still conducting early stage studies. The ECAR market is considerably more fragmented than other regions such as California, New England, and New York, which started deregulating earlier. There is no ISO or similar entity in place for the entire ECAR region, although the utilities in the region are proposing at least two plans for an independent system operator or a regional transmission operator. Given the competing proposals currently under consideration and the many divergent interests that exist in the ECAR region, any adoption of ISOs or similar entities will be gradual.
Generating money
Orion typically sells its products to electric power retailers, which in turn supply power to consumers. Power retailers include regulated utilities, municipalities, energy supply companies, cooperatives and retail "load" aggregators.
Orion may sell energy and ancillary services in advance under bilateral supply contracts with specific buyers. Alternatively, Orion may sell them into regionally operated day-ahead and real-time markets. The principal factor affecting recent changes in Orion's results has been the timing of its acquisition of new facilities. Carr Street Generating Station was acquired on November 19, 1998; Hydro Assets on July 30, 1999; New York City Assets on August 20, 1999; and Midwest Assets on April 28, 2000.
In consequence, Orion's results for the year ended December 31, 1998, reflect only corporate administrative expenses incurred following its formation in March 1998 and the operation of the Carr Street Generating Station from November 1998. Results for other periods include the operation of its facilities from the date of acquisition. From November 1998 until July 1999, Orion operated only the Carr Street Generating Station.
The expansion of Orion's operations in July and August 1999 and in April 2000 makes its historical financial statements less useful, either as a means of understanding its current financial situation or as an indicator of its future results, than might be the case with a more established company.
Orion's revenue was US$341.7 million for the six months ended June 30, 2000, compared to US$2.0 million for the six months ended June 30, 1999. The increase in the more recent period is a result of the ownership and operation of the Hydro Assets, the New York City Assets and the Midwest Assets, all of which were acquired after June 30, 1999. The six months ended June 30, 1999, reflect Carr Street as Orion's only owned and operating asset.
The revenue from each facility was determined at least in part in accordance with the various interim capacity and energy agreements then in place, including the provider of last resort contract for the Midwest Assets. The capacity sale agreement for the New York City Assets with Consolidated Edison expired in April 2000, at which time Orion began selling its capacity into the market.
Orion's revenue was US$134.1 million for the year ended December 31, 1999, compared to US$0.3 million for the period from March 10, 1998 (inception) through December 31, 1998. The increase in the more recent period is a result of the ownership and operation of the Hydro Assets and the New York City Assets, which were acquired after December 31, 1998, and the longer period of operation of the Carr Street facility in 1999.
According to the SEC filing, Orion reported a net income of US$5.7 million in 1999. But Orion has incurred substantial debt to finance its acquisitions. As of June 30, 2000, Orion had a total indebtedness of approximately US$2.3 billion, with approximately US$50.9 million available for future borrowings under its subsidiaries' various working capital facilities. In July 2000, Orion established a US$75 million revolving credit facility.
Team Orion
The management team has extensive experience in the power generation industry. I do like seeing that most of the members of the team have worked together for a while. Notice that Goldman Sachs affiliates own more than 54% of the company, and a subsidiary of Baltimore utility Constellation Energy owns 31%.
Orion's operations vary depending upon seasonal and regional weather conditions, although the effect of the seasons can vary depending upon the geographic location of the different facilities. In many areas, the demand for electric power peaks during the hot summer months, with energy and capacity prices correspondingly highest at that time. Orion earns a substantial amount of its net income from a few days during the peak demand for electric power on the hottest days of summer.
Look at a few of Orion's competitors, such as Allegheny Energy (AYE:NYSE), Enron (ENE:NYSE) and PG&E (PCG:NYSE). These companies have all been on an uptrend in the past year.
There's one thing that's a little disturbing. Current stockholders are selling over three million shares and Orion will not recognize any of the proceeds. But this may not be a big deal, since inside shareholders own a large piece of Orion.
I do like seeing that Orion Power Holdings, Inc. has a strong list of underwriters, including Goldman, Sachs & Co., Credit Suisse First Boston, Deutsche Banc Alex. Brown, Merrill Lynch & Co. and Morgan Stanley Dean Witter. Orion plans to trade on the NYSE under the ticker symbol ORN.
For more information contact Orion Power holdings, Inc., 7 East Redwood Street, 10th Floor, Baltimore, MD 21202, phone 410-230-3500, fax 410-234-0994.
Siu-Yee Ng is the editor of IPO Trader, an IPO alert service that helps readers profit on IPOs and, more importantly, the IPO Aftermarket. Click here to find out how you can put Siu-Yee's expertise and extensive contacts to work for your portfolio.
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