By Ted Caddell

Does NRG Energy know something the rest of the electric industry doesn’t? Some on Wall Street seem to think so.

After a week in which it scooped up more than a half-million retail energy customers from Dominion Resources and won approval for its acquisition of bankrupt Edison Mission Energy, NRG shares hit a 52-week high Friday.

Already the nation’s largest independent power producer, NRG will vault past Southern Co. to become the second-largest generator overall with the addition of Edison Mission’s 8,000 MW.

The Edison Mission purchase will add 5,062 MW to NRG’s 13,445 MW generating portfolio in PJM, giving it about 10% of PJM’s installed capacity, ranking it third behind Exelon Corp. and PPL. It also added 2,421 MW in the California ISO, with smaller amounts in MISO, ERCOT and non-RTO regions.

The purchase of Dominion Resources’ retail electric business, announced March 11, will bring it more than 600,000 customers in Illinois, Maryland, New Jersey, Ohio, Connecticut, New York, Massachusetts and Texas. NRG already has 2 million retail electric customers throughout the country served by its retail providers Reliant, Green Mountain Energy, Energy Plus and NRG Residential Solutions.

NRG expects to close on the acquisition by the end of this month. Neither company has disclosed the value of the deal.

NRG’s acquisitiveness is a stark contrast to the strategies of other large generators such as Dominion, Duke Energy and First Energy, which have announced a shift away from competitive retail markets in favor of regulated operations.

NRG, which has been built from a series of acquisitions and owns no legacy utilities, doesn’t have the option of falling back on a rate base.

Still, at a time when other generators are talking about selling or shuttering assets because of low capacity and energy prices, NRG’s decision to double down is a notable counterargument.

Turning Point?

Are we seeing a turning point in the fortunes of competitive generators?

Yes, say analysts at Credit Suisse, who last Friday raised their rating on Exelon to “outperform” and boosted their price target to $35 from $23. “We believe expectations and fundamentals for competitive power have found a bottom, with the potential for a long awaited recovery to take form over the next 12 months,” the company said.

Exelon shares closed yesterday at $32.93, up $1.57 (5%) over Thursday’s close. (NRG shares closed yesterday at $30.36, pulling back slightly from the 52-week high of $30.93.)

Exelon, which owns the largest generation fleet in PJM, could see its market share shrink if it follows through with threats to close one or more nuclear plants. (See Exelon in Lobbying Push to Save Ill. Nukes.)

PJM energy prices rose 10% last year as natural gas prices jumped 40%. (See State of the Market: PJM Passes, with Provisos) PJM’s efforts to limit the volume of imports and demand response that clears in the capacity market could also boost generators’ fortunes.

But most analysts are still labeling Exelon a sell or hold. So NRG’s bullishness carries with it risks.

The Street.com, which rates NRG a “hold,” said the company’s strong revenue growth and cash flow is offset by weak profit margins and decreases in net income and return on equity.

Goldman Sachs upgraded NRG to “buy” from “neutral” on Thursday, saying the company’s cash flow gives it the flexibility to buy back stock and debt, as well as make additional acquisitions.

NRG History

NRG is well aware of the risks. Born as an unregulated subsidiary of Minneapolis-based Xcel Energy, it fell into bankruptcy in May 2003 after several years of aggressive growth as a result of falling power prices and a decrease in energy trading following the implosion of Enron.

It emerged from Chapter 11 in December 2003, headed by a new CEO David Crane, who remains in charge today.

In late 2005, NRG purchased Texas Genco, the former generation arm of Reliant Energy, from a group of private equity firms. In 2009, it rebuffed a takeover bid by Exelon shortly after acquiring Reliant’s retail operations.

It added renewable power retailer Green Mountain Energy to its portfolio in 2010.

In 2012, it added GenOn Energy, the offspring of Reliant spinoff RRI Energy and Atlanta-based Mirant Corp., and one of the largest independent power producers in the U.S.

Last August it expanded into demand response with the purchase of Energy Curtailment Specialists.

Retail-Generation Synergies

Julien Dumoulin-Smith, a utility analyst at UBS Securities LLC, said the Dominion purchase makes sense for NRG as a way to find a market for its generation.

“When you are thinking about the retail markets, the reality is, if you are a large player, you want to be backstopped by a large generation portfolio,” he said.  In terms of retail energy, NRG “has wanted to expand from its core base in Texas to the Northeast for a while. This achieves that.”

NRG spokeswoman Melissa Hensley suggested that the acquisition was part of a long-term play by the company, which hopes to see more markets open to retail competition.

“This acquisition supports NRG’s strategy of growing its retail footprint,” she said in an interview Friday. “Additionally, NRG strongly believes in competitive markets. We want to ensure customers continue to be served through these markets, and we want to be an example for other markets that hope to open up to competition.”

Although Hensley wouldn’t say how many of those 600,000 new customers are in the PJM territory, she said about 80%, or 480,000, are in the Northeast, with the rest in Texas.

In contrast, Dominion has shifted its strategy to focus on regulated earnings. Since 2006, it has been selling off commodity-based operations, such as oil and gas exploration, and production and merchant generation, to concentrate on regulated businesses.

In January it announced its intent to exit the unregulated retail energy business, which had stalled in the last two years, with its customer count falling to 2.1 million, a 2% drop, since 2010.

It highlighted the challenges of the business in its 10-K filing for 2013, noting that it was competing against incumbent utilities with “the advantage of longstanding relationships with their customers and greater name recognition.”

Dominion will retain its nearly 2.4 million customers served by its regulated utility, Dominion Virginia Power.

Renewables

A bankruptcy judge in Chicago approved the sale of the Edison Mission assets to NRG for $2.6 billion. Edison Mission and subsidiary Midwest Generation filed for bankruptcy protection in December 2012, blaming low power prices, high fuel costs and expensive mandated coal plant retrofits. The deal is expected to close April 1.

The acquisition included 1,700 MW of wind, giving NRG more than 2,900 MW of wind and solar in operation or under construction.

That is one of the important points behind NRG’s acquisition, according to Dumoulin-Smith. “This plays into their desire to consolidate into the renewable sector,” he said. “This is something they really wanted to do.”

The Edison Mission generation assets are spread throughout the U.S., in California, Nebraska, Pennsylvania, Texas, Iowa, New Mexico, Minnesota, Illinois, Wyoming, West Virginia, Oklahoma, Utah and Iowa.

PJM Impact

With the EME acquisition, NRG will have about 18,500 MW of generation in PJM, leapfrogging AEP, Dominion and FirstEnergy in the RTO rankings.

The Edison Mission acquisition will boost NRG’s “economic capacity” market share in PJM from 6.8% to 9.4% during the high demand periods in the summer, according to an analysis the company filed with FERC in seeking approval for the purchase.

In CAISO, its post-merger share will grow to 8.3% from 7.3% during the peak winter periods, according to the analysis.

In MISO — the only other FERC-jurisdictional market in which NRG and EME had overlapping assets — NRG’s market share will increase to about 3.1% of total capacity, from 2.9%.

Market Monitor Seeks Mitigation

PJM’s Market Monitor expressed concern that NRG generation near a transmission constraint on the MISO-PJM seam — the Lanesville 345/138 kV transformer — could exert market power. The Monitor also cited a potential increase in market power in the PJM regulation market.

The Monitor asked the commission to require NRG to make cost-based offers in the regulation market and to continue to offer the same units and quantities historically offered into the regulation and Lanesville energy market.

The commission rejected the Monitor’s request for mitigation, saying that transmission upgrades have eliminated Lanesville as a constraint.

Because the Monitor’s analysis found market power screen failures in the regulation market for only 189 hours of the year (2%), “and many of these hours are non-contiguous and are spread over many time periods, we find there are no competitive concerns,” the commission said.