Deal's off, but CEG still wins

Constellation's value rises without FPL merger

April 01, 2007|By Paul Adams | Paul Adams,Sun reporter

Mayo A. Shattuck III's track record as a consummate deal-maker helped propel him into the executive suite at Constellation Energy Group.

The former investment banker helped engineer the public stock offerings of high-tech behemoths like Microsoft and America Online and orchestrated the sale of Baltimore's Alex. Brown & Sons to Bankers Trust Corp. in 1997.

But his best deal may be the one that got away.

In the five months since Constellation's proposed merger with FPL Group Inc. fell apart, the Baltimore energy conglomerate has seen its value soar along with predictions that wholesale energy prices could double during the next several years. And while consumers in Maryland and elsewhere cringe at the higher electricity prices they're likely to keep facing, the demand for power is fueling the stock prices for Constellation and other utility companies, analysts said.

At Friday's close of $86.95, Constellation shares are up more than 70 percent from the low they reached in May, when lawmakers threatened to hold up the merger amid debate over a 72 percent rate increase for customers of Baltimore Gas and Electric Co. The stock reached an all-time high of $88.20 Wednesday before retreating a bit.

Chief executive Shattuck killed the merger Oct. 25. But he already had spent months of backroom maneuvering aimed at positioning Constellation for life as a stand-alone company.

Since then, growth in its share price has outpaced FPL's, making the company's stock almost as valuable today as it would have been if the merger were consummated. Analysts say Constellation's good fortune is partly due to its well-timed exit from the FPL deal and its ability to deliver on promised earnings. But market forces that will eventually lead to more pain for electricity consumers are just as responsible.

"Right now there is a growing positive outlook on the part of investors with respect to the direction of power prices," said Paul Fremont, a Jeffries & Co. analyst.

"People see them going up a lot, and they [Constellation] obviously have nonregulated generation assets in Maryland and in New York, which would benefit significantly if that expectation proves to be correct," Fremont said.

Legislation temporarily limited the rate increase BGE customers were dealt last year, when rate caps that had been in place for six years were scheduled to expire. The utility's customers will begin paying full market rates this summer unless they opt for another deferral plan that state regulators will consider in coming hearings.

Though wholesale power prices have declined some in the past year, the expectation of higher power prices in future years is driving investor interest in Constellation and other companies that produce and sell electricity.

Demand rising

Much of Constellation's fleet of nonregulated power plants is in the Mid-Atlantic and Northeast, where demand for power is growing more rapidly than supply.

Nonregulated "merchant" power plants operate by selling electricity to the highest bidder in wholesale energy markets, whereas regulated power plants earn a fixed price set by regulators. Maryland deregulated its power market through legislation passed in 1999, resulting in all of the BGE plants being transferred to an unregulated Constellation subsidiary.

Those plants and others Constellation owns are rapidly gaining value because wholesale power markets are undergoing substantial changes aimed at increasing reliability in the grid. Federal regulators recently approved market rules that will make electricity more expensive in areas where electricity supplies are low and transmission lines are inadequate. The idea is to provide a bigger financial incentive for corporations to build power plants in areas where they are needed most.

That reasoning has been controversial within the industry and among consumer advocates, who say it is further evidence of failure in electricity deregulation. But market proponents say current prices are too low to make investment pay off, and federal regulators have followed that reasoning.

"There are very few businesses that set out on purpose to lose money," said Ray Dotter, a spokesman for the PJM Interconnection, which operates the power grid and manages the wholesale market for Maryland, 12 other states and the District of Columbia.

The densely populated region stretching from Central and Eastern Maryland to Northern Virginia is among those at greatest risk for increases under the new pricing scheme, referred to as the "reliability pricing model." The higher prices will favor Constellation, which owns low-cost nuclear and coal power generators throughout the zone. The rising value of those plants became a point of contention in last year's debate over deregulation and rising rates.

"Demand is growing and supply isn't, so if they're a generator, anyone who has existing assets, the value of those assets is growing," Dotter said.

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