By Chris O’Malley

A Québec pension fund has agreed to spend up to $593 million to acquire up to 30% of Indianapolis Power & Light from AES, which is seeking to lighten its share of U.S. utilities as their coal-fired generation in MISO and PJM face increasing environmental pressure.

IPL on Dec. 23 filed for Federal Energy Regulatory Commission approval on the deal (EC15-56), which also needs an OK from the Committee on Foreign Investment in the United States, an interagency group that includes the U.S. Treasury, Department of Energy and State Department.

Caisse de dépôt et placement du Québec (CDPQ) will pay $244 million for 15% of AES Investments, an IPL parent company, and contribute up to an additional $349 million for up to 17.65% of IPALCO Enterprises, IPL’s direct parent, based on capital calls.

At the end of the two-step process, CDPQ will have indirect ownership of 15% to 30% of IPL and will be able to nominate two IPALCO directors. AES Investments would nominate nine of the directors.

Environmental Pressures

IPL, which owns about 2,623 MW of coal-fired generation (83% of its total), is scrambling to comply with the Environmental Protection Agency’s Mercury and Air Toxics Standards (MATS), and may face compliance expenses under the EPA’s proposed carbon emissions rule. In its earnings report for the second quarter, AES said it was too soon to determine what impact the carbon rule, and state plans for implementing it, will have on the company.

From 2014 to 2016, IPL plans to spend $326 million on MATS compliance alone.

At least half of IPL’s capital spending plan involves replacement of coal-fired units. The biggest project, at $600 million, is the construction of a 671 MW gas-fired generating station to replace aging coal units at its Eagle Valley plant, 30 miles south of Indianapolis.

AES’ Second Thoughts About U.S.

Although it is based in Arlington, Va., three-quarters of AES’ pre-tax income from continuing operations comes from its international investments.

AES, which bought IPL in 2000 for $2.15 billion, would see its stake in IPALCO fall to 70% under the deal.

Earlier this year AES tried to sell its Dayton Power & Light’s generation fleet rather than spinning it off into an unregulated subsidiary by 2017, as the Public Utility Commission of Ohio had ordered.

AES bought DPL in 2011 for $3.5 billion, about a 9% premium to DPL’s stock price. But AES later expressed regrets about the purchase, saying it hadn’t received the benefits it expected. In its 10-K filed last February, AES cited Ohio’s market-based pricing and low wholesale prices.

In July, however, AES said it had dropped its plan to sell DPL. “In light of the potential recovery of power prices, as well as PJM capacity prices, AES believes that this business has additional value that can be captured by continuing to own and operate these generation assets,” AES said in a statement.

Moody’s Likes Deal

Moody’s Investors Service said in a Dec. 15 report that the sale would help the credit rating of IPALCO, which is in the midst of a $1.4 billion capital spending plan.

“CDPQ’s contractual commitment is credit positive for IPALCO and its wholly owned subsidiary Indianapolis Power & Light … particularly considering CDPQ’s strong credit quality compared to AES,” Moody’s analyst Natividad Martel wrote.

Moody’s did not change its ratings for IPL, IPALCO or AES, however, which are Baa1 stable, Baa3 stable and Ba3 stable, respectively.

IPL has a current capital structure of 45% equity and 55% debt. Virtually all of the utility’s profits are returned to AES as dividends, which has left the utility thinly capitalized. In the first nine months of 2014, IPL paid $78 million in dividends to AES.

Over the last two years, AES contributed $156 million in additional equity to IPL, said Moody’s.  AES and CDPQ will contribute another $62 million on top of CDPQ’s $349 million.

Although it would ultimately receive less in dividends from IPL, AES would enjoy a reduction in requirements to make equity contributions to IPL. That will “enhance AES’ parent only free cash flow position,” said Moody’s.

That’s notable because AES recently announced it would double dividend distributions starting in the first quarter of 2015.

As of Sept. 30, IPL had an available borrowing capacity of $249.3 million under its $250 million unsecured revolving credit facility after outstanding borrowings and existing letters of credit.

CDPQ

The purchase is being made by CDP Infrastructure Fund GP, a New York-based investment fund and a wholly-owned subsidiary of CDPQ.

CDPQ has a controlling interest in Gaz Metro Limited Partnership, the biggest natural gas distributor in Quebec and the 100% owner of Vermont’s Green Mountain Power.

In MISO, in which IPL operates, CDPQ has a 24.7% interest in Invenergy Wind, whose projects include Bishop Hill Energy III, in Henry County, Ill.

IPL is asking FERC for expedited approval of the CDPQ deal. Even with Invenergy Wind’s current and proposed projects, Invenergy and IPL would own or control on a combined basis 2% of MISO’s installed generation capacity, IPL said in its filing. IPL noted that FERC recently accepted market-based rate filings by affiliates of Invenergy Wind based in part on the passive nature of the CDPQ interests.

New Source Review Liability

IPL, meanwhile, could find itself facing other environmental costs outside of its $1.4 billion capital program.

Although not mentioned in the context of the CDPQ deal, IPL remains haunted by the specter of a 16-page Notice of Violation the EPA handed the utility in 2009.

It alleges IPL updated three generating plants over 23 years without adding the most modern pollution controls. The EPA’s New Source Review (NSR) requires utilities to undergo a pre-construction review for new plants and whenever existing plants are modified in a way that involves “non-routine” physical changes resulting in a significant increase in emissions.

IPL contends that the maintenance projects were routine.

In its third-quarter earnings report, AES said it has met with EPA officials to resolve the NOV and noted that in other NSR cases the EPA has “required companies to pay civil penalties, install additional pollution control technology on coal-fired electric generating units, retire existing generating units, and invest in additional environmental projects.” Such an outcome could have a “material impact” on IPL and AES, the company said.

One such case involving similar allegations cost American Electric Power $75 million in penalties and environmental projects as part of a 2007 settlement with the EPA. AEP agreed as part of the settlement to make $1.2 billion in additional sulfur- and nitrogen-control upgrades at its Rockport and Clinch River generating plants.

AEP’s settlement came after almost eight years of litigation.