Following through on climate promises

The TXU deal represents a sea-change in how Wall Street views carbon risk. But transparency, accountability and – ultimately – delivery are now crucial, say Jon Sohn and Smita Nakhooda

The proposed $45 billion leveraged buyout of TXU Energy, announced in late February, and initiated by Kohlberg, Kravis, Roberts & Co and the Texas Pacific Group, represents a significant step forward in how the financial community, and private equity firms in particular, approach the opportunities and risks of climate change (see Environmental Finance, March 2007, page 6).

A cornerstone of the agreement by Texas Energy Future Holdings Limited – the private equity entity – is a commitment to scale back TXU’s massive investments in coal-fired power from 11 proposed new plants to three, thus significantly reducing anticipated greenhouse gas (GHG) emissions.

The buyout, backed by Goldman Sachs, Citigroup, JP Morgan, Lehman Brothers and Morgan Stanley, signals a new era of banking leadership and increased investment in clean technology.However, transparency, stakeholder engagement and accountability will be essential to manage the many challenges of implementation and ensure that this deal delivers on its promise.

The agreement does more than limit new coal-fired generation. A related commitment by TXU includes a shift in corporate policy in favour of federal legislation to regulate GHG emissions. Other commitments include increased TXU support for demand-side efficiency and renewable energy. Subsequent to the agreement,TXU also issued a press release announcing a plan to build two integrated gasification combined cycle (IGCC) plants. The IGCC plants would gasify coal, extract carbon dioxide (CO2) and other pollutants, then burn the resulting hydrogen gas for power production. The captured CO2 could be sequestered underground in deep geological formations, or used for local enhanced oil recovery (although in this latter case, only a portion of the CO2 may remain permanently sequestered).

The precedent-setting agreement signals investor support and anticipation of federal GHG legislation, and marks an important step forward in the implementation of Wall Street’s commitments to tackling climate change.These policy shifts illustrate the kind of good governance enlightened investors can bring to the power sector.

One participant in the buyout, Goldman Sachs, committed in its landmark environmental policy framework – published in November 2005 – to analyse carbon reduction opportunities in its investments and to work to reduce these emissions whenever practical and feasible.

TXU – will new buyers live up to their promises?

The buyout agreement, if executed effectively, is a clear step toward implementing Goldman’s policy statement. The TXU agreement represents a signal from public and private financial houses that incorporating climate change risk and working with the environmental community can result in competitive advantage and healthy profits.

Analysts note that the three plants left on the table are the most feasible and profitable plants under consideration. Some have even suggested that most of the other plants would never have been built and that the buyout represents a ‘deal’ that effectively silences the environmental community while allowing three major new, carbon-intensive coal-fired generation units to be constructed. While it is clear that the agreement has many merits, the mechanisms to assure compliance with these additional parts of the TXU deal need to be reviewed and made as transparent as possible.

Aspects of the TXU agreement and how it was reached still face scrutiny from Texas legislators and communities impacted by TXU’s investments. Government representatives and citizen stakeholders will need to hold private investors accountable for following through on their commitments, and their input will need to be considered as implementation proceeds. In addition, shareholder review and approval of the proposed acquisition are still pending.

While hailed as a climate change victory, the following ongoing and outstanding issues are worth considering:

State government officials and public consumers are concerned about possible rate hikes as a result of the buyout. TXU has promised a 10% reduction in rates by 2008.Yet the buyout deal will require servicing of at least $12 billion in debt, leading some observers to question whether lower rates for consumers are feasible.There is a possibility that state legislators may review rate impacts, and potentially seek to block the merger.

The commitments that investors in TXU environhave made are voluntary. It remains to be seen what fuel and technology choices will replace the 9,000MW of coal power TXU had proposed, and how long the new investors will retain ownership of the utility.

TXU had managed to gain approval to fasttrack the coal permit application process, bypassing alternative energy investments that a coalition of Texas cities (the Texas Clean Air Coalition) wanted to pursue. Some assessments suggest the electricity needs of Texas residents could have been met more quickly, cheaply and cleanly through investments in energy efficiency and solar and wind power generation.

Citizens affected by the three coal-fired power plants still on the table remain concerned about the local pollution impacts these plants are expected to bring. Plans to address local pollution do not seem to have been a central component of the agreement – and are of particular relevance given that the plants would rank among the 10 largest sources of mercury emissions in the US.

Counter-offers from other private equity firms are still a possibility – with Blackstone, the Carlyle Group and Riverstone reportedly in the frame – and could render the agreement and commitments reached moot.

Regardless of who owns TXU, a key issue going forward for this private equity-funded entity is how it will be held accountable to its commitments and the ongoing concerns of citizens of Texas. Stakeholders – both locally and those investing in the new ownership group – will need to monitor these commitments.We will undoubtedly see new and innovative ways to hold these largely unregulated actors to account.

Notwithstanding, it is clear that this agreement is a major milestone. It represents a first for US energy investment, where private equity investors are using their cash and capacity to bring clean technology online rapidly. If we can now get the governance and follow-through right, the financial and environmental benefits will be enormous.

Jon Sohn is a senior associate and Smita Nakhooda an associate at the World Resources Institute, a Washington, DC-based environmental think-tank.
E-mails: jsohn@wri.org, and snakhooda@wri.org

SUBSCRIBE for the full story each month 0 0