The Masters of the Universe Screw Up Again

Texas' biggest utility is slowly collapsing under mountain of debt. Thanks deregulation!


Chalk up another victory for electricity deregulation.

The company formerly known as TXU – reborn in 2007, after the largest leveraged buyout in history, as Energy Future Holdings Corp – appears to be slowly collapsing under its own weight. It seems that the Masters of the Universe have screwed up again, this time predicting that natural gas prices would remain near historical highs, thus propping up their super-leveraged investment.

The Dallas Morning News reports:

Buyout barons Kohlberg Kravis Roberts & Co., TPG and the private equity arm of Goldman Sachs Group might ultimately turn a profit, but at the moment, they are as upside down on this deal as a two-bit Las Vegas condo owner.

What happened here is a story as old as the free-market system itself. Sometimes – whether you buy a house, a stock, pork bellies or a giant electric utility company – the market will turn against you with a vengeance.

Home prices sometimes drop, stock prices drop, bacon prices drop and electricity prices drop – and all that is even more financially devastating when the deals are built on debt. These private equity firms basically made a humongous bet, with borrowed money, that natural gas prices would continue to rise and cash would continue to flow into the coffers of EFH.

They thought limited supplies would keep pushing natural gas prices higher, analysts said.

What they didn’t anticipate was a possible 100-year supply of natural gas that would soon flow from the Barnett Shale, the massive geological formation spanning 5,000 acres in North Texas, and similar deposits across the country. Those supplies have driven down prices by more than 50 percent on the natural resource that accounts for nearly half of Texas’ electricity production.


This company, like all companies with heavy debt and declining revenue, has to figure out a way to reduce its debt before the day of reckoning arrives. The most pressing issue the company faces involves $20 billion in debt that must be paid back in 2014. That’s about half of the company’s long-term debt.

The question that virtually everyone involved with EFH is asking is whether it can roll over or extend when it must come up with the $20 billion.

“There are people who say, ‘Yes, they can, but it will cost them.’ And there are people who say, ‘No, they cannot,’ ” Hempstead said. “Moody’s doesn’t have a view on that, but this is a big, giant maturity that is facing these guys.”

How did we get to the point where Wall Street high-flyers are putting millions of families at risk by making wild guesses on volatile markets?

Back in the boring old days before electricity deregulation, TXU was Texas Utilities, a regulated public utility subject to the oversight of state regulators. If Texas Utilities wanted to raise rates or sell a power plant or buy another company, it had to ask permission from regulators charged with looking after the public good. The system was far from perfect but it at least had the virtue of accountability to the public. Back then, no one would have dreamed of loading the state’s largest utility up with billions of dollars of debt so private equity firms could make a buck. That all changed in 1999 when the Texas Legislature, urged on by the jeniuses at Enron, deregulated the electricity sector. The market would fix everything, cheerleaders like felon Jeffrey Skilling promised.

Deregulation led to quite a bit of reshuffling among the major players in Texas but TXU (the company changed its name in 1999) emerged well-positioned to take advantage of the new landscape. Unlike competitor Reliant, TXU didn’t shed its coal and nuclear power plants. That was smart. The power generation market in Texas is built so that natural gas sets the price for all fuel types. When gas prices are high, coal and nuclear make a mint. So in 2006 the company decided to go on a coal-fired power plant building spree, announcing plans for 11 new plants. But TXU ran into a shitstorm of opposition and after months of tremendously negative publicity seemed to be on the ropes. Enter the Masters of the Universe.

During the 2007 legislative session, private equity firms KKR and Texas Pacific Group announced their $45 billion deal, which included environmental concession, including an agreement to scrap eight of the 11 plants. In the business press, hosannas rained down on the supposedly “green” deal. “Capitalism’s legendary ‘Barbarians at the Gate’, made infamous by KKR’s acquisition of RJR Nabisco in 1989, have become a bunch of tree-huggers,” wrote The Economist.

In truth, reaction from environmental groups was mixed. Some environmentalist felt it was the best deal they were going to get. Others believed TXU should have been slain without the help of the private equity boys.

Consumer advocates, on the other hand, were deeply skeptical of the deal. Regulators in other states, they pointed out, had blocked similar debt-laden buyouts of public utilities on the premise that the risks were too great.

Texas regulators – enamored as always with the fruits of deregulation – were quite sanguine. The most skepticism Public Utility Commission Commissioner Barry Smitherman could muster was to warn the new owners not to screw a good thing up.

“What I would ask is that these new owners would be very cognizant that it probably takes one more stupid thing to screw up this market design,” Smitherman said in October 2007.

“I don’t know what it is, I don’t know what it would be. It’s sort of like pornography. I’ll know it when I see it.”

Three years later, Energy Future Holdings Corp. is in deep doo-doo. To be clear, the effect on consumers so far has been minimal and there’s no reason to believe that the company is going to jack up rates, shutter power plants, or ignore maintenance of the power grid. However, what happens if the company fails to pull itself out of its debt spiral? Will the owners begin selling off assets? Will the company go into bankruptcy? Will it try to boost its margins by ratcheting up electric rates?

Just askin’.

Regardless of what happens, the owners, including the giant vampire squid itself, aren’t gonna go hungry.

KKR, TPG and Goldman Sachs, which are collecting management fees from EFH, all declined interview requests. According to regulatory filings, EFH said it accrued $36 million in fees last year from the private equity firms. That compares with $35 million in 2008 and $18 million in 2007.