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Paul Singer and NRG Energy aim to reshape power business

Power producers have struggled to figure out a winning model since the late 1990s, when many states broke up large utilities to allow competition in segments like generating power and selling electricity to end users.

To some degree, that’s simply due to the challenge of operating businesses that invest in assets with high sunk costs within a market that’s difficult to predict, said Tony Clark, a former commissioner of the Federal Energy Regulatory Commission. But there are other recent factors at play.

“The pressures that are facing it now are different,” said Clark, now a senior adviser at law firm Wilkinson Barker Knauer. “In recent years, it’s been a combination of gas and government.”

The unexpected boom in U.S. natural gas production over the last decade has pushed down power prices, making it harder for companies that operate plants to turn a profit.

At the same time, state and federal subsidies and other support for renewable energy projects have boosted competition from wind and solar power. Since wind and solar power have very low marginal costs, transmission companies put electricity generated by renewables on their lines first, and turn to natural gas and coal plants to meet remaining power demand.

Much of NRG’s business is focused on selling electricity generated at power plants into the wholesale market, where utilities buy it and then sell it to customers. With power prices low, it’s hard for power generation businesses to make money in this line of work. But NRG also has a retail business that buys electricity on behalf of customers, and that segment does well when power prices fall.

The more profitable retail business will account for a bigger share of earnings after the transformation. Analysts have generally expressed support for that broad strategy.

“Pairing those two businesses can reduce the overall volatility of earnings and can offset either side in a market dislocation,” said Travis Miller, director of utilities at investment research firm Morningstar.

But many remain concerned about what will be left of the generation business.

“They have a generation fleet in Texas that’s mostly weighted towards baseload nuclear and coal,” said Neel Mitra, director of utilities and power research at investment bank Tudor Pickering Holt. “Those assets are in a really tough environment largely because natural gas prices are low and wind is crushing the off-peak pricing.”

While the plan improves the company’s financial standing by reducing debt, it introduces risks to its business, according to ratings agency Moody’s.

“The scale of the divestiture will significantly reduce NRG’s size and cash flow diversity, an important consideration for companies exposed to volatile commodity prices,” Moody’s analyst Toby Shea wrote in a research note.

“Because NRG’s renewable business is an important source of stable cash flow and long-term growth, its partial or full sale is credit negative for NRG,” he said.

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