In August and September TXU Europe negotiated with Drax to find possible ways to ter-
minate the PPA. Alternatives that TXU Europe reportedly considered included paying Drax
US$700 million to restructure the offtake contract, so as to be at market prices; or buying a
stake in Drax from AES. However, these possible measures became less realistic as TXU
Europe began to face its own earnings problems.
In early October TXU announced plans to infuse about US$700 million into its
European operations, primarily those in the United Kingdom. However, on 14 October the
company reversed these plans. After substantially reducing its earnings estimates for the
year, TXU said that it planned to abandon its European wholesale and retail electricity
businesses altogether. The company also announced that it would cut its dividend by 80
per cent in order to preserve cash and, if possible, maintain its US parent-level investment-
grade credit rating. The credit rating for the company’s European subsidiary, TXU Europe,
was downgraded from ‘BBB-’ to ‘BB’ by Fitch, from ‘Baa3’ to ‘B3’ by Moody’s, and
from ‘BBB-’ to ‘B+’ by Standard & Poor’s. The downgrade of TXU Europe’s ratings to a
level below investment grade potentially triggered the early repayment of bonds and col-
lateral calls from trading counterparties. That, of course, did not have a direct bearing on
its negotiations with Drax, because it was in Drax’s interest to keep the above-market PPA
just as it was.
AES and TXU Europe began discussions on a restructuring of the hedging contract on
14 October. TXU did not make the £20 million payment due on that day for the electricity it
purchased in September. As a result AES gave notice to TXU, as of 15 October, that it must
deliver a letter of credit in favour of Drax in accordance with the terms of the hedging con-
tract. On the same day, as a result of the credit rating downgrades on AES Drax’s debt, TXU
gave notice to Drax to deliver a letter of credit in its favour, also under the terms of the hedg-
ing contract. If Drax failed to issue the letter of credit, TXU could terminate the contract with-
in 20 days, although there was a 90-day cure period.
On 15 October Fitch reduced its rating on TXU Europe’s senior unsecured debt and on
obligations guaranteed by TXU Europe to ‘CCC’. As a result the agency also downgraded
the ratings for the AES Drax Holdings senior secured bond and the InPower senior secured
bank loan from ‘BB’ to ‘CCC’, and for the AES Drax Energy senior notes from ‘CCC’ to
‘CC’. At the same time Moody’s reduced its rating on the InPower senior bank debt from
‘Ba2’ to ‘Caa1’ and the rating on the AES Drax Energy subordinated notes from ‘Caa2’ to
‘Ca’. Fitch dropped its ratings for the AES Drax Holdings and InPower bank debt from
‘BB’ to ‘CCC’, and its rating for the Drax Energy subordinated notes from ‘CCC’ to ‘CC’,
just above the ‘D’ imminent default level. Similarly, Standard & Poor’s dropped the
InPower and AES Drax Holdings senior debt to ‘CC’, and the AES Drax Energy subordi-
nated debt to ‘C’.
Both Fitch and Moody’s noted that Drax would not be able to make its interest payments
if it had to arrange new contracts for its power in the open market, and that it could not rely
on support from AES, its parent, which was also facing financial pressures. Moody’s noted
that if the TXU Europe contract failed AES Drax might be able to claim up to £270 million
(US$420 million) in compensation, but those funds would go entirely toward the retirement
of US$1.4 billion in senior bank debt issued by InPower, which was linked directly to pro-
ceeds from the TXU contract. The agency also noted that if Drax went into receivership the
unencumbered asset value of the power station would be considerably below book value and
that the proceeds from liquidation would not cover all senior secured liabilities.
DRAX, UNITED KINGDOM