How private equity squeezes cash from the dying U.S. coal industry

Private equity firms are proving there’s still plenty of profit in the U.S. coal industry despite a decade of falling demand for the fossil fuel. They are spending billions of dollars buying coal-fired plants on the cheap – and getting paid even when they are not providing power.

The lucrative investments illustrate how fossil fuels will remain an important part of the energy mix – and continue spinning off cash for investors – even years after demand for them peaks as the world transitions toward cleaner energy sources.

The need for reserve power was on display during the utility crisis this month in Texas – the only U.S. grid system that operates without such an emergency system. A cold snap knocked out several of the state’s generating plants and triggered widespread blackouts, leaving a wake of human suffering including several dozen deaths.

The so-called capacity payments are given out in most U.S. power markets, and regulators tend to favor coal-fired generators that store heaps of coal on site when other power sources might be disrupted. In the Pennsylvania, Jersey, Maryland Power Pool (PJM), which has the largest standby market, capacity revenue payments average more than $100 per megawatt per day – an insurance policy that costs about $9 billion a year and aims to make sure the grid’s 65 million customers avoid blackouts during heat waves and Arctic blasts.

“The capacity power market is a certain source of revenue for coal plants that might otherwise be uneconomical,” said Sylvia Bialek, an economist at New York University’s Institute for Policy Integrity.

The administration of former President Donald Trump, a Republican, encouraged capacity market incentives for coal-fired generators. But President Joe Biden, a Democrat, is likely to change those policies in the coming years as part of an effort to slash nearly all of the U.S. power sector’s reliance on fossil fuels by 2035.

In the meantime, private equity firms are in a good position to compete for capacity payments because traditional utilities are under pressure from activist shareholders to reduce greenhouse gas emissions and to limit debt.

The private equity owners of Ohio’s Gavin Power Plant in the PJM grid, for example, have squeezed hundreds of millions of dollars out of the facility since buying it four years ago, even though it only runs about 60% of the time.

Lightstone Generation LLC – a joint venture between Boston’s ArcLight Capital Partners LLC and New York-based Blackstone Group Inc – took on $2.1 billion in debt from Wall Street banks to buy the plant and three much smaller gas-fired units from American Electric Power Company Inc in 2017, according to term sheets viewed by Reuters.

From 2018 to 2020, Lightstone’s power plant operations produced about $1.1 billion in operating profit, according to estimates from Moody’s Investors Service. Up to 50% of Gavin’s cash flow comes from being on standby for emergency power, according to several economists and credit analysts.

About 18 months after the Gavin acquisition, ArcLight and Blackstone went back to Wall Street to finance most of a $375 million special dividend they paid to themselves, according to credit rating agencies. Such dividends are a way for private equity firms to lock in profits and shift risk to their debt-holders, which are often mutual funds. If the business does well, the debt gets paid off at a premium. But if the business fails, the debt-holders end up with equity stakes in plants of declining value.

ArcLight did not respond to requests for comment. Blackstone declined to comment.

The private equity firms’ backers have also been making money on the investments, according to filings. The state of Connecticut’s retirement plan, for example, invested $85 million in ArcLight’s Energy Partners Fund VI, which holds stakes in the Gavin plant along with other energy investments, and has seen returns of about 8%.

Meanwhile, mutual funds that invested in Lightstone’s debt are receiving payments pegged to a floating interest rate that has ranged from 4% to 6% – far higher than about 1.4% on the U.S. benchmark 10-year yield.

Absolutely vital

Other private equity firms have also been betting on coal power capacity payments.

Atlas Holdings, for example, led a joint venture to buy New Hampshire’s Merrimack Station coal plant in 2018, the centerpiece of a $175 million acquisition of generators from New England-based utility Eversource Energy.

Atlas declined to comment.

Source: Reuters