The TXU Europe contract offered some mitigation of that risk. Moody’s also observed that
Drax would have reduced flexibility in selling power not dispatched by TXU Europe, having
to sell through the balancing mechanism in relatively illiquid markets rather than through the
Pool system, which had had virtually unlimited liquidity.
AES’s high risk profile began to work adversely in 2001 before Enron’s problems
became apparent. On 26 September the company reduced its earnings outlook significantly,
citing weakness in the value of the Brazilian real and lower wholesale energy prices, espe-
cially in the United Kingdom. The company’s shares lost 49 per cent of their value in a sin-
gle day.
Between March 2001, when NETA was implemented, and the end of the year, wholesale
electricity prices had dropped 30 per cent. Other factors contributing to the lower prices were
the ample supply of natural gas, falling prices on gas-fired plants because there were more
sellers than buyers, and increasing competition from older plants that, in recent years, had
been purchased and tuned up to operate at higher efficiency and lower cost by international
power companies such as AES.
Enron Corporation filed for bankruptcy protection on 2 December 2001. The collapse of
this enormous company caused investors and lenders to become sceptical about other com-
panies in the power business, whether or not they were traders, and about companies with
complicated accounting. AES suffered in this environment, although its problems related pri-
marily to emerging markets and its UK merchant power exposure, and it had not been accused
of any accounting or other misdeeds.
Later in December 2001 the credit ratings of two US energy trading firms active in the
UK market, Dynegy Inc. and Mirant Corporation, were downgraded and a third, El Paso
Corporation, held on to its credit rating only after substantially strengthening its balance
sheet. Calpine Corporation, owner of the 1,200 MW Salt End power station in the United
Kingdom, was the first IPP downgraded by the rating agencies.
At the end of the month Moody’s downgraded the AES Drax Ltd subordinated notes two
notches from ‘Ba2’ to ‘B1’, based on three factors: the prospect that counterparties would be
tightening credit requirements and procedures; Drax’s dependence on the hedging contract
with TXU Europe; and its increased exposure to merchant risk after 2007. The agency
observed that counterparties were beginning to cut their limits to some power companies by
as much as 50 per cent and some were starting to settle weekly rather than monthly.
In February 2002 Standard & Poor’s put its ‘BB’ rating for the Drax plant on
CreditWatch with negative implications, but identified the hedging contact with TXU Europe
as an important factor supporting the current rating. In early March Moody’s put the Drax
subordinated notes, rated ‘B1’, on review for possible downgrade, and maintained the ‘Ba1’
ratings on the senior secured bonds and senior secured bank debt with a negative outlook.
Drax had requested that the senior secured lenders waive an event of default relating to a
breach of insurance requirements, and requested a distribution to AES Drax Energy Ltd to
allow payment on the subordinated notes and a dividend to AES Corporation. Because that
waiver was not granted by 28 February 2002 Drax made its required interest payment from
the Debt Service Reserve Account dedicated to the subordinated notes. As a result of changes
in the insurance market after 11 September 2001 Drax was not as fully covered as required
by the bank loan agreement. The company therefore was in technical default and needed a
waiver from the bank lenders. After the interest payment the Debt Service Reserve Account
no longer had sufficient funds for the scheduled interest payment on the subordinated notes
POWER PLANT