Turning Away from Merchant Generation, AEP Unveils $17.3 Billion Capital Budget in Regulated Markets

Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--American Electric Power Company Incorporated (NYSE:AEP) (Columbus, Ohio) last month finalized the sale of four power plants in the competitive PJM Interconnection market, netting about $2.1 billion, which it intends to invest in its regulated transmission operations. The sale, first announced last September, is an important step AEP is taking to exit competitive power markets and focus on its regulated utility business.

On January 30, AEP finalized the sale of four merchant power plants, totaling 5,200 megawatts (MW), to Lightstone Generation LLC, a joint venture of Blackstone Group (NYSE:BX) (New York, New York) and an affiliate of ArcLight Capital Partners LLC (Boston, Massachusetts). The plants, all located in the PJM (Pennsylvania-New Jersey-Maryland) Interconnection (Valley Forge, Pennsylvania), include:

• Lawrenceburg Generating Station, a 1,186-MW, natural gas-fired plant located in Lawrenceburg, Indiana
• Waterford Energy Center, an 840-MW, natural gas-fired facility located in Waterford, Ohio
• Darby Generating Station, a 507-MW, natural gas-fired generator located in Mount Sterling, Ohio
• General James M. Gavin Plant, a 2,660-MW, coal-fired plant located in Cheshire, Ohio

The Columbus-based utility-holding company, which serves nearly 5.4 million customers in 11 states, has been stung badly in competitive power markets, where its legacy power plants (mainly coal) are not competitive with newer and more efficient gas-fired power plants. The low price of natural gas is a critical factor in separating winners from losers in competitive power auctions.

Last November, in its third-quarter earnings statement, AEP took a non-cash $2.3 billion asset-impairment charge, relating mainly to its ownership share of 2,684 MW of coal-fired competitive generation in Ohio, including the Cardinal, Conesville, Stuart and Zimmer plants. The charge also includes the competitive portion of the Oklaunion Plant in Texas, Desert Sky and Trent Mesa windfarms and some coal-related properties, AEP said.

In discussing full-year 2016 earnings with investors last month, Nicholas Akins, AEP's chairman, president and chief executive officer, said the company has two options with those competitive plants: It could sell them, or create a regulated structure to which AEP would transfer those assets. AEP is not the only power provider that has taken a bath in competitive markets. Last year another Ohio utility, FirstEnergy Corporation (NYSE:FE) (Akron, Ohio), took a $1.5 billion asset-impairment charge to reflect deactivating five coal-fired units in the Buckeye State. For more on that, see February 6, 2017, article - Stung by Competitive Power Markets FirstEnergy Focuses on T&D Investments.

In mid-January, in a talk delivered at Evercore ISI Utility CEO Retreat, AEP officials told investors and investment analysts the company had completed its strategic review of competitive assets, it was reinvesting proceeds from sales wisely, and it was growing its regulated businesses. Going forward, company officials said, AEP was well-positioned as a regulated business.

While some portion of that future involved environmental projects at several power stations, by far the largest areas for investment in the next few years were transmission projects and regulated purchase power agreements (PPAs) for generation, mainly renewables.

Over the 2017-19 period, AEP has set a capital budget of $17.3 billion, about 74% of which (roughly $12.8 billion) is scheduled to be invested in its regulated transmission & distribution (T&D) projects. All of the capital spending will be done in AEP's regulated businesses and contracted renewables. The company's capital spending averages about $5.8 billion per year over 2017-19. Industrial Info is tracking 114 active capital and maintenance projects valued at $1.89 billion in its North American Project Platform.

Click on the image at right to see a pie chart summarizing AEP's three-year, $17.3 billion capital plan.

Between 2017 and 2019, AEP's transmission holding company expects to make about $4.7 billion of capital investments. AEP's Appalachian Power unit plans to invest about $2.6 billion over the next three years, while the Texas Central unit plans to invest about $2.1 billion.

Click on the image at right to see a table summarizing the capital spending plans for AEP's various businesses.

Looking forward, AEP officials said a regulated energy company would have higher growth, higher dividends and less risk than the hybrid regulated-competitive business AEP had been running for several years. Exiting the competitive generation business will return AEP's earnings and risk profile to the fully regulated business model is had operated for decades before electric markets were restructured, they added.

Increasing its investment in transmission will improve system reliability by replacing aging infrastructure, officials said. Those investments also would enhance system resiliency to extreme weather while increasing physical security. Further, the transmission investments would better integrate renewable generation and position the company favorably to support future environmental mandates. The planned transmission investments also would relieve electric congestion and make the generation market more efficient, possibly lowering electric prices for customers.

To give investors a sense of how badly its regulated businesses need this capital investment, AEP officials said about 7,145 circuit-miles of its transmission and distribution lines were over their life expectancy. Nearly 1,400 transformers were similarly operating beyond their design life. And more than 2,000 circuit breakers were beyond their life expectancy. Those numbers all are expected to grow over the next decade, showing the need to invest in the core T&D business.

In bulking up in its T&D business, AEP is in no danger of becoming a stand-alone transmission company. Company officials told investors and analysts AEP's regulated business planned to make significant investments in renewable generation and gas-fired power, either as rate-regulated projects, where AEP would own the assets, or through purchase-power agreements, where AEP contracted for the power. Over the next 17 years, from 2017 through 2033, AEP plans to invest in a total of 5,400 MW of wind generation, 3,400 MW of solar power and 3,000 MW of gas-fired generation, company officials said.

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