Something has to give. Spurred on by the deregulation of the US power sector, private power developers have been quick to cash in and acquire as many generation generation assets as they can. The past few years have been characterised by a period of frenetic activity. Since the beginning of 1999, this activity appears to have reached fever-pitch. And while big-ticket power companies mop up some of the best deals, some smaller players are focusing on single-sale assets and greenfield developments. Closely behind the companies are the lenders who have been just as quick to cash in on the rich rewards to be found in the US power market. But while the volume of deals looks set to keep lenders busy for the next few years, lenders and sponsors should watch out.

Speaking at a recent conference in New York one banker commented that while there are a number of single plant purchasers going on, wise developers will have to look beyond single unit purchases. Perhaps a better way of putting it, is that smaller developers may make money in the short-term from one-off transactions, in the long term the excessive competition in certain states will mean that companies who got in first and who have a portfolio of deals, stand to gain the most. And the banks are responding to this trend. Says Jared Brenner, director in the project finance department at WestLB in New York: "We target larger developers and we look for lead or first tier roles."

Jonathan Bram, managing director in the project finance department at Credit Suisse First Boston in New York believes that smaller companies such as LS Power are doing a good job. But Bram concedes that, "with large deals like the ComEd transaction, there are only about three companies or so that would be able to bid". A glance at any of the three power companies profiled in this article demonstrates that smaller power developers will not only have to be quick but clever to succeed in this market. Panda and PSEG, for example, have signed a joint-venture agreement to develop projects in Texas. Says Jeoffrey Moore, regional vice-president for the US at PSEG Americas in Ridgewood: "PSEG wanted to develop strategic interests in areas outside of the northeast of the US. At the same time, we didn't just want to do single plant transactions but rather we wanted to create a portfolio of projects."

Early developments in the US has focused on three regions ? the northeast, California and Texas and this is where the bulk of activity has been occurring with a scattering of deals in other states. Says Erwin Thomet, managing director in the project finance division at ING Barings in New York: "Among other issues, the US power market continues to evolve differently in various States, creating unique sets of challenges in each region. Power exchanges continue to evolve and pricing history remains very limited and possible involvement of regulators continues to introduce uncertainty. The financing of existing power plants, with relatively high heat rates and operating costs, increases the challenges of evaluating the underlying markets and the long-term competitiveness of the assets in their respective markets."

With some talking of over 50,000MW of power under development and others talking of over 30% of all power utilities having been sold, there is a serious danger that late players into the sector will find themselves stuck with the remnant deals. Lenders and developers are aware that some regions are already over saturated. Says one banker in New York: "Institutional investors buying project bonds do not seem to have reached their limit for the US but they do have limits for certain regions and certain companies. In New England some people are just not in touch. There is so much announced development and it won't all be built." More importantly some companies are going to have trouble financing these deals.

Says Credit Suisse First Boston's Bram: "It is clear that if all the energy projects go ahead in Nepool then there will be significant over-capacity. Investors will look at their exposures in the same way as the banks." The argument here is not whether banks will mop up debt that the capital markets do not take or vice versa but whether some power companies will be left with dead assets.

In fact, while there has been a rise in capital markets transactions in recent months, for the bigger deals it is not a question of deciding to use bond or bank. With transactions of $1 billion and above, companies are not relying on one financing source. There has been a tendency towards shorter tenor commercial bank loans which are then taken out by either a long-term loan or a capital markets transaction post construction. According to WestLB's Brenner such semi-perm financings provide some advantages: "It helps bring in participating banks who would otherwise be nervous of financing a merchant power deal. However this does mean that the deal may carry greater refinancing risk."

Says Thomet: "The majority of greenfield transactions in the merchant environment have been financed on a non-recourse basis. Some transactions were financed on balance sheet and subsequently refinanced in the bank or debt capital markets." Thomet adds: "The capital markets have for some time now provided sponsors with a viable long-term source of debt capital and will continue to be an important source of capital. ING Barings does not limit itself to any single product and works with sponsors to arrange the best suited debt, or combinations of debt sources, for any given transaction.... A notable feature of many financings these days, is the introduction of cash traps and sweeps based on coverage ratio threshold levels."

Meanwhile, officials at ratings agencies Standard & Poor's and Moody's have been overwhelmed with the volume of US project bond issues which they are asked to rate. With many projects selling power into the spot market, the agencies are also faced with merchant risk. The deals are significantly more complex. One banker says that the backlog of work is beginning to slowdown transactions. But some believe that there is a wider concern. The pipeline of deals is also slowing down and while it will take several years before it is exhausted, it could be much sooner before lenders and institutional investors turn their attention to emerging market transactions where the risks are higher but the rewards are better.

CMS ? reacting to change

Lucrative foreign markets dominate the agenda of Dearborn-based CMS Energy while a development strategy in the US heartland takes shape.

Project financiers laud the company's US track record while conceding CMS is less active domestically than a number of its competitors. World-wide the company's generating capacity has more than tripled since 1993 and it boasts more than 6,556MW under construction or in advanced development.

Says one project financier: "CMS has participated in many small megawatt sized projects in the US while focusing on a considerable number of overseas deals. CMS saw a lot of very good international growth opportunities very early on, and they have done a very good job at getting in early when capital was scarce. A lot of CMS' project financings have been done on the strength of their ability to pump equity into those transactions from their parent company."

In the US, CMS Generation pioneered new territory in the energy sector in 1990 when the company financed the $2.3 billion Midland Cogeneration Venture and became the first organisation in the world to successfully convert an abandoned nuclear facility to a 1,370MW natural gas-fired combine-cycle plant. CMS controls 671MW of the Midland Cogeneration Venture facility in Michigan, which is the largest cogeneration plant in the US.

The company is operating several US plants with relatively small MegaWatt capacities, and is developing larger plants in Michigan including the 710MW Dearborn Industrial Generation project and the 254MW Michigan Peakers facility.

Additionally CMS is financing the acquisition of Panhandle pipeline through a progression of corporate finance activities. In March, CMS completed a $2.2 billion acquisition of Panhandle Eastern Pipeline, Trunkline Gas and Trunkline LNG, comprising 10,400 miles of mainline natural gas transmission pipe, from two natural gas production regions in the US; north through the Midwest and into Michigan ? Texas, Louisiana, Gulf of Mexico area and the Mid-Continent which includes Kansas, Oklahoma, and the Texas panhandle region.

Says one banker: "The Panhandle deal was CMS' foray into doing a big domestic deal, it just happened to be a pipeline, as opposed to a power plant and that helped balance out their cash flow between international and domestic efforts."

Alan Wright, senior vice president and chief financial officer at CMS Energy in Dearborn says pipelines will provide a framework for power station development that is still unattractive.

Says Wright: "I'm a little bearish on the profitability of merchant generation in the US for a while. By that I mean generation that's known as base-load, which runs all the time generation. We're bullish on peak-load capacity, that stuff which can start up very quickly, fire on gas, and meet demand like we've seen during the heat waves this summer. The market for steady state power, that operates 24-hours a day is going to be damn tough. So what we see is not only ourselves but others building on these gas oriented projects all the way up an down our pipes in the middle belt of the country." Market players wager CMS' strategy may pay off if the company can remain flexible.

Says one banker: "If they are nimble enough they will react quickly and adopt the changes and survive. So the result is that, that CMS is one of those cases where, so far, their successes are attainable to their tenacity and their ability to just learn as they go along."

Edison Mission Energy ? Two of the biggest deals

Two large acquisitions by Edison Mission Energy set the tone for the US power industry in 1999. One of those acquisitions ? likely to be the largest power sector transaction of the year ? is Edison-

Mission's plan to acquire seven coal natural gas-fired generating plants plus peaking units at an additional five sites from Commonwealth Edison. The $5 billion transaction is pending approval from state and federal regulators. Financing is expected to close in late September/early October, for the 12 Illinois facilities which have a combined capacity totaling 9,261MW.

In March the California-based company closed financing and completed acquisition of the $2.1 billion Homer City power project. Homer City's 1,884MW makes it the largest coal-fired facility to serve both the New York Power Pool (NYPOOL) and the Pennsylvania, New Jersey, Maryland (PJM) market. Its stacks are the largest in the US. Edison Mission's recent development efforts were applauded by most project financiers in 1999. Says a banker in New York: "I think Edison Mission is an extraordinarily well managed company. They are a company that is aggressive, but prudent and very creative in finding ways to add value." The banker says that Edison Mission's uses independent consultants to obtain spot market power prices for their initial proposal for Homer City. "Edison Mission established a trading operation to market physical capacity and will be able to significantly improve the 1999 earnings and cashflow because of that."

Another banker directly countered those attributes and compared Edison Mission to Enron, commenting, "Enron is really in the business of making money and they've chosen to do it in the power and energy sector, but Edison Mission Energy is in the business of providing power and in the process, they'll hopefully make money," remarks the banker. "I think it's because when they were originally set up as subsidiary of this very large utility, I don't think the disciplines were built in that strongly," he continues. "When I look at Mission I don't get a team that pervades all the things that they do the way I have with Enron for example...there's just no broad strategy."

Comparing Edison Mission to Enron the banker contends that Enron is willing to commit a large amount of capital at risk, bolstered with strong marketing the ability to dictate terms to their customers and financiers.

James Iaco, president of the Americas region for Edison Mission in Irvine, denied the company ?leaves money on the table' and defended the company's competitive position. "We don't leave any money on the table. For Homer City the back up bid was under 2% ? or in 98% of our bid and the back up bid on Commonwealth Edison was so incredibly close it came down to people," says Iaco.

Iaco says the company is studying the US market closely for opportunities in the wake of continuing deregulation. "If opportunities show themselves region which we will enter them. There are markets we have chosen at this point, probably not to pursue unless certain things change," says Iaco, who declined to say which regions this might be. "We look at each of the NERC regions and then break down each of those regions into their submarkets and trying to decide where we want to be," explains Iaco. "There are three things that tell us where we want to be and what plants we want to own, whether they be existing plants or new greenfield projects. One, the market must have clear, sound fundamentals. Two, the assets need to be well positioned to have strategic transmission access. Homer City is a great example of that as a plant that can access two pools, PJM and New York Power. And thirdly, we've got to have a positive environmental story, especially when we're looking at old utility coal assets."