So began “Anna Karenina,” Leo Tolstoy’s great masterpiece. It’s a truth that, if applied to real estate deals, could be expressed only slightly differently.
“Perfect real estate deals create universal happiness; every imperfect real estate deal creates unhappiness in its own way.”
As Colorado Springs Utilities moves closer to buying the 50 percent interest in the Front Range Power Plant that is currently held by private investors, one thing is sure: someone is going to be unhappy with the deal.
And if Bill Cherrier, CSU’s general manager of financial services, has his way, CSU ratepayers won’t be the unhappy ones.
CSU partnered with private investors to build the 440-megawatt gas-fired facility eight years ago. When the plant first went online, most of its output was sold on the spot market, with local demand only accounting for a small percentage of sales. But as local demand increased, CSU accounted for a larger and larger share of the plant’s output, rising to nearly 90 percent this year.
The partnership agreement between the municipal utility and Northern Star Generation gives CSU a buyout option which has to be exercised this year. The investors suggested that CSU ought to pass, as it has twice in previous years.
But Cherrier, like any canny real estate investor, decided to assess the value of the option.
His estimate: $10 million-$15 million.
Northern Star’s response: we’re not paying you a dime. We’re calling your bluff — go ahead and exercise the option.
Cherrier wasn’t bluffing.
Less than 18 months ago, CSU had dismissed out of hand the notion that the utility might convert its existing coal-fired dinosaurs to gas, or otherwise expand the Utility’s gas-generation capabilities. But today the availability of extremely low-interest tax-exempt financing coupled with low natural gas prices has changed the equation.
Even with increased use of gas to generate electricity, sparked both by environmental considerations and massive new gas discoveries in the continental United States, the inflation-adjusted wellhead price of gas is less than it was during 1982.
Most utilities use gas to meet peak demands, while relying on coal for base-load generation. That’s because gas has been more expensive than coal, and also because it’s a lot easier both to start and to shut down gas turbines. It’s easy to close a valve and wait for higher prices — not so easy to shut down a coal mine.
But in today’s climate, gas producers are more willing to ink long–term deals.
CSU’s option doesn’t have a specified price. It uses a simple structure that’s familiar to any real estate investor.
CSU and Northern Star (owned jointly by UBS Infrastructure Asset Management and the Ontario [Canada] Teachers Pension Plan) each select an appraiser to determine value.
If the two appraisers’ estimates are within 5 percent of each other, the partners split the difference and that’s the price. If not, the two appraisers jointly select a third appraiser, who decides on a final price.
In this case, the two estimates were a lot more than 5 percent apart.
CSU’s appraiser pegged Northern Star’s equity interest at $51 million, right in line with its own internal analysis. Northern Star’s appraiser came up with $128 million.
Why such a difference?
There are three approaches to appraisal — market comparison, income, and cost. Market comparison is doubtful, given that there are few comparable transactions. Income is problematical, given the inherent uncertainties of the market. Replacement cost may argue for the higher value, but that’s not a consideration here.
On Nov. 9, CSU, Northern and the two appraisers will make their case to the third appraiser, who will serve as judge, jury and executioner. Too high, and the deal’s dead.
So what’s too high? Cherrier won’t say. He did, however, note that if CSU could buy Northern’s interest for $50 million, the net present value to CSU would be close to $150 million. Ratepayers could save millions, benefiting from tax-exempt financing and the end of equity withdrawals by Northern Star.
The likely outcome, based on back-of-the-envelope calculations by one who is generally incapable of managing his own finances: CSU buys it for $76.5 million.
And with the purchase, gas and renewables will for the first time in the city’s history amount to more than 50 percent of CSU’s generating capacity.
Next step, to misquote Ronald Reagan: “Mr. Cherrier, tear down that downtown coal-fired dinosaur!”
Hazlehurst can be reached at email@example.com or 719-227-5861. Watch him at 7:20 a.m. every Tuesday and Friday on Channel 3, Fox Morning News.