By Ted Caddell

The short history of merchant generation in the U.S. is strewn with the fragments of once high-flying Wall Street darlings that crashed and burned. Remember Sithe? Boston Generating? Orion?

And it’s not just small, under-capitalized operations or industry newcomers that have found the merchant generator model perilous.

Duke Energy Corp., the largest U.S. utility owner, announced last week that it no longer wants to be in the merchant generation business in the Midwest, and is selling its interest in 13 power plants in Ohio, Illinois and Pennsylvania.

Duke’s decision to sell 6,600 MW of generation — the bulk of its merchant fleet — came just days after the Ohio PUC refused the company’s request to bill regulated customers $729 million to make up for a shortfall between generation power costs and plunging wholesale power prices. The company said that it expects to take a charge of $1 billion to $2 billion from the sale, which they expect to close in 12 to 18 months.

Its decision to take a loss to get out of that part of the business came not just because of the shortfall.

Too Volatile

“Our merchant power plants have delivered volatile returns in the challenging competitive market in the Midwest,” said Duke Energy President and CEO Lynn Good. “This earnings profile is not a strategic fit for Duke Energy.”

Companies like to give investors what they want, and investors value certainty. A market that swings on fuel prices, volatile markets and weather is not certain.

It’s not just Duke that finds itself in the vise of high generation costs and low wholesale prices on the power market.

St. Louis-based Ameren Corp. exited the merchant generation business entirely late last year when it sold its five coal-fired plants in Illinois to Dynegy. It cited, in part, a desire to concentrate on its regulated – read more predictable – electric, natural gas and transmission operations.

FirstEnergy last month cut its dividend by more than one-third and announced a renewed focus on regulated operations after a year in which the company’s stock fell 20% on weak earnings from its unregulated unit. (See Reboot for FirstEnergy.)

Exelon, which cut its dividend by more than 40% a year ago, announced last month that it might mothball some of its nuclear stations in the face of what it says is unfairly subsidized renewable power and stiff competition from gas-fired generation. “Despite our best ever year in generation some of our nuclear units are unprofitable at this point in the current environment due to the low prices and bad energy policy,” Exelon CEO Chris Crane said. (See Exelon May Close Nukes.)

Julien Dumoulin-Smith, an analyst for UBS Investment Research, told the PJM General Session Feb. 12 that locational marginal prices at Exelon’s Quad Cities nuclear plant on the wind-rich Illinois-Iowa border were negative in more than 1% of the hours in 2013, with an average negative prices of -$15.35/MWh. For all hours, average LMPs were less than $26/MWh.

De-Integration

Dumoulin-Smith said the Duke announcement is further evidence of what he called the “gradual de-integration” of the industry, and predicted other publicly traded utilities will also withdraw from the merchant generation business to concentrate on their regulated businesses.

Paul Fremont, analyst with Jeffries & Company, wouldn’t draw industry-wide conclusions in the wake of Duke’s announcement, but said some companies have already indicated a strategy that doesn’t concentrate on merchant generation. “Dominion not going to increase exposure” in merchant generation, he said, “and I think PPL has indicated it may exit.”

Dominion is among the utilities that have scaled back their non-regulated businesses. It announced at the end of January that it was selling its retail electric business, perhaps by the end of this quarter. “The margins in the electric side of business have been shrinking,” Dominion CEO Tom Farrell said during an earnings conference call. “And you see increased volatility happening.”

Shrinkage Among IPPs?

The stresses faced by merchant arms of integrated utilities also face pure-play independent power producers. Before long, suggested Dumoulin-Smith, “there’s going to be three or four IPPs left…Maybe two?”

He said it’s conceivable that a merchant nuclear portfolio could drop below investment grade, suggesting a roll-up by an IPP would obtain a single B credit rating. But with debt so cheap, he said, “I’m not sure it matters a heck of a lot.”

Impact on Midwest Capacity

Duke’s exit plan, and Exelon’s warnings, comes on top of a wave of coal plant closures resulting from environmental regulations and low natural gas prices.

MISO late last year predicted a shortfall of 5 to 7 gigawatts of capacity in 2016-17 due to loss of coal-fired generation. A survey released this month, however, suggested the shortfall might be only 2 GW or less.

(See sidebar: Merchant Generation Remains Bumpy.)