Some independent power producers failed to contain capital and O&M costs, adding to financial pressures.
Holt Bradshaw is an energy industry specialist with PA Consulting Group.
Merchant generators can substantially increase cash flow by revamping their capital allocation processes. Based on several recent client engagements, a PA Consulting study found that merchant generators often follow a flawed allocation process that misappropriates cash toward wasteful maintenance and capital expenditures, resulting in reduced asset values and erosion of precious cash reserves.
Our study of recently acquired generation assets representing 36 plants and 32,410 MW found a lack of control in the level and growth of non-fuel maintenance expenses and of capital allocated to projects related to operations and maintenance (O&M). Even more troubling is that this lack of investing discipline occurred at a time when merchant producers were under very serious financial pressures.
This situation is the result of a poor capital allocation process that often fails to:
- Tie capital or O&M plans to the company's production strategy;
- Rigorously analyze multiple options and risks for each project;
- Evaluate the impact of single projects on the entire portfolio of investments; or
- Manage the benefits and risks of the projects and portfolio.
O&M Expenditures
Initially, we discovered a disturbing rise in the non-fuel maintenance expenses of divested assets. This is surprising because conventional wisdom suggests that merchant owners of divested plants tend to be very cost-conscious, trying to squeeze as much profit from their recently acquired assets as possible compared with their previous owners — regulated utilities that could pass on operating costs to ratepayers.