Perfect storm
By December 2001 Calpine’s financial outlook had been changed by a confluence of events
that included recession in the United States, declining power prices resulting from a cool
summer followed by a mild winter, the collapse of Enron and a sort of guilt by association
that spread throughout the power industry. Calpine’s share price plunged from US$60 in mid-
2001 to US$6 in February 2002. Calpine’s CEO, Peter Cartwright, emphasised that Calpine
had an asset-based business profile that was not comparable to Enron’s. However, following
Enron’s bankruptcy the entire power industry was subjected to closer scrutiny and Calpine
became a target because of its aggressive growth. The company also had a Houston-based
trading operation, which began to have difficulty when market conditions changed, and some
transparency issues. While Calpine was not accused in any way of improper accounting, the
amount of interest that it was able to capitalise while its plants were under construction was
considered by some to create a misleading picture of earnings growth, although it reflected a
common power industry practice. Of course no one had ever seen a power company with such
an aggressive plant construction programme.
In mid-December, amid market jitters related to the Enron bankruptcy, Moody’s down-
graded Calpine once again to a ‘BB’ rating. The agency was concerned about the precipitous
decline in Calpine’s stock price as well as well as the reduced operating cash flow available
to service its heavy debt burden.
At the same time Standard & Poor’s assigned a ‘B+’ rating to a planned issuance of
US$400–500 million of convertible debentures due in 2006, and affirmed its ‘BB+’ corporate
rating and its ‘BB+’ rating on the company’s senior unsecured debt. The ratings reflected the
following risks.
- Current market conditions could hurt Calpine’s business and put some stress on its liqui-
dity. The company could be forced to exceed its targeted ratio of debt to capitalisation
because of the reduced power demand, reflecting the recession, lower power prices and
the difficulty of issuing equity. - Calpine’s merchant portfolio represented one third of its capacity, exposing the com-
pany’s cash flow to potential volatility, as demonstrated by the dramatic swings in power
prices in California and other western states during 2001. Even contracted revenues
could be affected by market cyclicality, to the extent that contracts expired and were
replaced with new contracts at higher or lower rates. - Calpine had substantial exposure to the California market through contracts with the
Department of Water Resources and Pacific Gas & Electric Company, which represent-
ed about 25 per cent of its cash available for debt service in 2005. The California Public
Utility Commission had publicly challenged the validity of these contracts and Calpine
had begun talks to renegotiate them. - Calpine’s minimum and average consolidated FFO interest coverage ratios of 2.2 and 2.8
times fell below the investment-grade targets for the next five years set by Standard &
Poor’s for developers with a speculative component to their revenue streams. The risks
were exacerbated because about 25 per cent of Calpine’s debt was at floating rates. Once
again these ratios reflected the agency’s adjustment to include guarantees on lease pay-
ments and partial debt treatment of convertible preferred stock. - Calpine’s target of 65 per cent debt to total capitalisation made the company vulner-
able to electricity price volatility or a period of sustained price depression. The
POWER PROJECT PORTFOLIO