Gar Seifullin Managing Director EP Energy Finance Group

1
Gar SeifullinManaging DirectorEP Energy Finance
Group

• Gulf Coast Power AssociationCurrent Trends in
  Energy Financing Markets,
• A Mezzanine Lenders Perspective
• April 3, 2002

2
Executive Summary

• Rebalancing of sector financial and business risk
  still in process
• Financing markets, both debt and equity, still
  volatile
• Wholesale power market truly working but perhaps
  too well
• True cost of capital much higher absolute cost
  of equity high nominal cost of debt lower,
  but...

3
Merchant Industry Snap Shot
Capital Providers View

• Capital providers trying to balance business and
  financial risk
• First down side of typical capital intensive
  commodity industry
• How low can it go? Below short run marginal
  cost?
• Electrical demand down in 2001
• First time in last 15 years
• Industrial demand off 12, size of rebound
• Prices down
• 20002001 on-peak revenue 4144/MWh
• 2002 revenue estimated to be 33/MWh
• 20002001 average industry spark spreads fell
  from 35/MWh to 12/MWh
• 2002 average industry spark spread estimated to
  be 10.5/MWh
• Futures prices do not provide return on equity
  nor debt coverage

4
Capital Providers Crystal Ball
Significant Factors
Optimist
Pessimist
Supply Economy Price signals Regulatory Liquidity
2022 V Projections Level/30 Sufficient
2830 Double dip Futures Incumbent/70 Lacking
5
Debt Markets

• Power sector, including utilities, consumes more
  debt capital than most borrowers think
• 90 billion in 2001, 30 billion in IPP
• Lenders have alternatives and significant
  exposure
• Macro trends negatively impact availability of
  credit from largest sourcesyndicated loans from
  commercial banks
• Troubled portfolios, economic recovery, cause
  uncertainty for banks
• Fewer transactions but also less pressure to grow
  balance sheet in short term

6
Debt Markets

• Cost of debt low on a nominal level, yet
• Underlying rates low, but not relative to
  inflation
• Credit spreads up, yield curve steep
• Availability, terms, and conditions shift risk
  and raise true cost
• Pro forma revenues
• Non-linear costs cost of running CCGT at 50?
• Super peak period income less given over-capacity
• Intrinsic versus extrinsic values

7
Debt Markets

• Huge overhang in the form of refinancings
• 20022005 30 billion
• 20062010 30 billion
• Pro forma coverages of 3.0x now 1.?x
• What if spark spreads stay low?
• Will capital markets open for refinancing?
• Rating agency concerns
• Debt markets appetite/size for investment-grade
  paper
• Late calls on recent bankruptcy in both the
  utility and merchant sector
• Rating agencies control
• Refinancing/key to other large capital markets
  (typically 144A)
• Holdco financings/off takes that depend on
  strength of sponsor

8
Debt Markets

• Falling assets/project/firm values
• Distressed asset likelihood is high Nasty
  surprises at Corp./Hold Co. vs. Project levels
• Sponsor reaction unknown What assets will be
  sold at what price?
• Realization that transitions in the power market
  are atypical of a commodity business?
• Chemicals, refining, pulp and paper, steel
• Oil Gas Industry40/60 Energy Merchants60/40
• Can the business ever earn its cost of capital?
• What variables need to be underwritten?

9
Equity Markets

• Amount of equity invested in industry, including
  utilities, larger than most think 20 billion in
  2001 alone
• Period of plentiful strategic equity is over
• Attractive growth story has become cyclical
  commodity play
• Per kW of capacity profitability down
• Cost of equity has risen, P/E ratios have fallen
• March 2001March 2002, index of 6 companies 24x
  to 8.1x
• Exit costs are high
• 6080 GW in the 20022003 pipeline with a cost of
  3040 billion Can you afford to stop?
• Cost to access incremental capital versus exit
  costs
• Need to grow earnings versus need to deleverage

10
Equity Markets

• Future equity story
• Better business model Energy merchants, pure
  plays, TD?
• Two tier revenue stream
• Reserve margin lt1015 marginal value
• Reserve margin gt1517 marginal cost
• What is investor risk-adjusted discount rate for
  cash flows in this sector?
• Distressed assets/projects
• Likelihood is low (note difference compared to
  debt view)
• Capital providers reaction
• Non-recourse deals provide only one way out
• Genco or Hold Co. deals provide more back doors
  which lenders may force
• Pressure on management to rationalize/optimize
  portfolio
• Asset sales only attractive if value received is
  greater than capital employed

11
Equity Markets

• Sources of incremental capital
• Dilutive impact of new expensive equity
• Impact of less leverage/inexpensive debt
• Internally generated cash flow now cheapest
  available source of equity capital availability
  given project level sweeps
• Trend-to-date of large corporate-like debt
  financings may change
• Regulatory constraints
• Highly sensitive consumer product
• Desire for concentrated higher price market
  versus political impact of less competition

12
Outlook and Alternatives

• Lower supply of higher cost capital versus
  dramatically diminished opportunitiesImpact on
  projects in process?
• Mergers/acquisitions to reduce cost
  structureConflict with market power issue?
• Asset optimization and associated incremental
  capital
• Financial or passive equity that complements but
  doesnt compete with owner
• Joint ventures
• New players who want domestic market share

13
Conclusions

• Debt and equity providers face increasing levels
  of uncertainty regarding investment in the power
  sector
• Greater levels of uncertainty translate into
  higher risk
• Higher risk translates into more expensive
  capital
• More expensive capital reduces investment in the
  industry
• Reduced investment brings supply and demand back
  into equilibrium during commodity industry cycle

14
Gar SeifullinManaging DirectorEP Energy Finance
Group

• Gulf Coast Power Association Current Trends in
  Energy Financing Markets,
• A Mezzanine Lenders Perspective
• April 3, 2002

15
(No Transcript)