Who Owns the Power Plants?

Power plants are the beating heart of civilization. That’s ‘heart’, singular, because they beat as one. Spinning generators across the grid spin in synchrony, and the electrons that flow through your home oscillate at a matching frequency.

Although they function almost as one machine (certainly as one system), they operate under diverse ownership structures. Power plants on the same grid are owned not just by different companies, but by various classes of market participants with different types of financial backing.

The primary types of operating companies that own power plants are regulated utilities, independent power producers (IPPs), and electricity retailers. Their backers include public equity investors, private equity, institutional investors, and project finance lenders.

Each player has their own position in the market, and they make investment decisions in the context of the unique advantages and distinct needs of their position. This creates specialization between them regarding both the types of projects and the stage of the project’s life in which they get involved. For example, 90% of solar plants are owned by IPPs while 85% of nuclear plants are owned by public companies.

As a result, energy transitions are ownership transitions. When the country goes through waves of investment in new generation - in natural gas in the 1990s and 2000s, then in wind starting the mid 2000s, followed by solar in the early 2010s - the result is not only a turnover in the country’s power generation inventory but a turnover in who owns the power plants.

Market Participants

Prior to the 1980s, power plants were only built by vertical utilities, the old-school power companies. They own the power plants and distribution lines, and, if you live in their territory, they’re the entity to which you pay your power bill.

Vertical utilities are government-approved monopolies with captive customer bases. And - most importantly, in the context of project finance - their rate of return is guaranteed by regulators. Their state regulator will let them charge whatever prices are required to recoup their expenses plus a reasonable profit.

The utility’s guaranteed profit means that they take no risk when developing projects.

A large power project often requires an investment of tens of millions of dollars even before construction begins, with no guarantee that the project will be profitable once completed, or that it will be completed at all. To any other developer, this constitutes a significant risk - but utilities get a guaranteed profit on these expenses even if the project is canceled before completion.

One might expect that regulated utilities would undertake more building than developers that bear all the risk themselves, but they don’t. Regulated utilities need the blessing of regulators to undertake new projects, and regulators are understandably cautious about giving approvals. There’s also the fact that the utilities have the corporate culture of 100+ year old regulated monopolies, because that’s what they are. The net effect is the regulated utilities undertake less new building than IPPs.

Independent power producers (IPPs) are non-utility companies that build power plants and make money selling power to utilities, industrial customers, or into the wholesale market. This type of market participant was created in a limited form by an act of Congress in 1978, and over the years they gained more freedom to operate on par with the utilities. When many state grids were ‘deregulated’ starting in the 1990s, utilities in those states were required to sell their power plants to IPPs.

Another type of market participant that may own power plants is the electricity retailer. Retailers can buy power wholesale from IPPs, but it makes sense for them to have their own power plants as well. They have a large structural ‘short’ position in power. They’re on the hook for delivering power to their customers every day, for years to come. Owning a power plant is a structural ‘long’ position. So building or buying power plants lets them move towards market neutrality, if that’s what they want.

For much the same reason, large industrial users of power often own their own on-site power generation. They may also use their generation for backup power, for example if they have expensive equipment that could be damaged by a sudden blackout. And, I don’t know for certain if this happens, but I imagine they switch to their generation during load peaks, when large surcharges are added to the power price on some grids. Many larger university campuses have a gas-fired power plant on campus.

Finally, some government agencies own power plants. Hydropower plants are ~80% owned by government agencies, typically by the public authority that manages the waterway.

IPPs have undertaken significantly more new construction than regulated utilities over the last 20 years. Although they face risks that utilities don’t, IPPs move faster and are more opportunistic. IPPs accounted for half of all power plant construction during the 1990s¹. Today, they own 58% of wind and 47% of wind², because they do the vast majority of the development.

The comparative advantage of regulated utilities is large capacity projects with capital costs that are too high for IPPs and their financial backers. Utilities still own 50% of coal plants, which tend to be larger, and to my knowledge every nuclear plant ever built in the U.S. was built by a regulated utility.

Financiers

Just about every power plant is owned by a project company, a special purpose vehicle that’s only concerned with developing and operating that plant. The project company would be capitalized with cash equity from its sponsor (the utility, IPP, or retailer) and other equity investors, and would then raise debt from project finance lenders.

Financing doesn’t have to be raised on a per-project basis. The parent company could raise corporate debt or equity to use across projects or to finance its general corporate needs. This has the obvious advantage of reducing the number and therefore cost of transactions.

There are other less obvious benefits³. Corporate financing gives the capital partners a stake in all of the company’s projects. This makes it easier for the power plants to work as a system. No one will mind if, for example, Plant A delivers power to Plant B’s customers while Plant A is down for maintenance. Whether a company versus project or corporate financing tells you something about their longer-term strategy.

From a risk perspective, corporate finance spreads the investor’s risk over more projects, but in project financing they have the benefit of having their capital fenced off from risks to the parent company.

The money comes from those places in the world where money naturally forms in pools: bank deposits, institutional investors, public equities investors, and sometimes the U.S. Treasury.

The classic institutional investors are pension funds, insurance companies, endowments, and sovereign wealth funds. These entities all have long-term outlay obligations: the schedule of retirements and, regrettably, deaths; anticipated insurance payouts; and planned building and infrastructure maintenance.

The primary need of these investors is long-term reliable returns, so that they can meet their future outlay obligations⁴. Their primary comparative advantage is that they have lots of free capital, but the scale of the capital they’re working with limits their options for where to put it.

Infrastructure has been a great match for institutional investors. It has low sensitivity to the business cycle, low correlation with the stock market, long-lasting cash flows that grow with inflation - and it can absorb a lot of capital.

The most common way for institutional investors to get exposure to power generation infrastructure is by investing in infrastructure-focused private equity (PE) funds. These are typically closed-end funds, meaning they have a limited amount of money to deploy over a fixed period of time. Their goal is to maximize returns. While no one PE fund provides reliable long-term returns, institutional investors get smooth returns by backing a large number of funds.

The comparative advantage of PE funds is that they’re willing to move fast, be opportunistic, and get operationally involved. Institutional investors can’t possibly be operationally involved with the deployment of their billions, so they pay management fees to PE funds that can.

These qualities of PE-backed IPPs are a great fit for developing new projects. As I’ve said, getting a new plant project off the ground is a grind and highly uncertain. While the capital probably could be raised in the public equities market, investors would probably demand a very low earnings multiple. PE-backed IPPs are over-represented among owners of plants at the start of their life.

Institutional investors rarely participate at a power plant’s greenfield stage, but they do sometimes directly invest in power generation. They like to co-invest in established projects, providing a partial exit for the PE-backed IPP that developed it.

They especially like renewable power. Prior to ~2012, direct investment by institutional investors in power generation was uncommon. But they’ve become more common, and almost entirely in the form of investments in renewable power projects.

Windmills look great on a pension fund’s brochure, but that’s not what attracted them. Because renewables don’t require fuel, there’s no fuel risk to worry about. That makes net profit more predictable, which means it’s easier to see how a direct investment in a renewable power project contributes to the long-term reliable returns that institutional investors want.

And as the asset reaches the end of its life, it often ends up back in the hands of PE-back IPPs. End-of-life assets require more maintenance. They also often produce more environmental externalities - both because the oldest assets tend to be last-generation technologies that are more polluting, and because age causes them to run less efficiently. Public IPPs and retailers, especially those sensitive to public scrutiny regarding environmental concerns, may want to get rid of them. Opportunistic PE-backed IPPs⁵ seize on this.

Putting this together, we see the pattern of the life cycle of a typical asset. It’s developed by a development-focused PE-backed IPP, maybe passing through one or two transactions before becoming operational. It’s probably operated by its developer for some time, until that developer reduces its take by selling to public IPPs, retailers, and institutional investors. Those players hold the asset for most of its life, and then either retire the asset or sell it on to a PE-backed IPP.