AN ENERGY FUTURE HOLDINGS BANKRUPTCY

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1 Snapshot Report: AN ENERGY FUTURE HOLDINGS BANKRUPTCY MARCH 2014 tcaptx.com

2 P1 An Energy Future Holdings Bankruptcy Energy Future Holdings ( EFH ), the state s largest electric company, has declared bankruptcy. What prompted this massive financial collapse and how will it impact rates? What does it mean for the Texas energy market? Quick Facts When EFH was formed in 2007, it was a result of the largest leveraged buyout in history. Approximately $37 billion in borrowed money was used to finance the deal. 1 Oncor operates the transmission and distribution of electricity in north and west Texas, in the areas noted below in red, while Luminant (wholesale generator) and TXU Energy (retail electric provider) operate throughout most of the state. The EFH bankruptcy is the 10th largest in U.S. history. 2 The financial collapse of EFH should not cause consumers to lose electric service. The impact to home electricity bills remains uncertain. The eventual disposition of Oncor, the company s regulated utility, and Luminant, the company s wholesale unit, could significantly impact rates. Depending on the eventual disposition of Luminant, an EFH bankruptcy could undermine or enhance the long-term health of competition in the state s wholesale electricity market. By the Numbers $36.4 $28.8 Total Value of Assets of EFH and its affiliates. Value of Assets Associated with EFH s Competitive Operations, such as Luminant and TXU. $49.9 $41.7 Total Liabilities of EFH. Total Liabilities Associated with EFH s Competitive Operations. Source: First day motions filed by EFH in the U.S. Bankruptcy Court for the District of Delaware. All values as of Dec. 31, 2013.

3 P2 An Energy Future Holdings Bankruptcy The Background Energy Future Holdings was born in 2007 the product of a debt-heavy buyout of TXU Corp., the Dallas-based energy giant. The company soon began posting annual losses, and on April 29th, 2014, it filed for bankruptcy. The sheer size of the EFH collapse is worrisome. Luminant, its deregulated wholesale power company, controls nearly 20 percent of the capacity within the state s principal electricity market. Oncor, its regulated wires company, owns more than 119,000 miles of transmission and distribution lines. The deregulated retail unit, TXU Energy, directly serves more than 1.7 million residential customers. 3 (Re)Organization Chart Energy Future Holdings Corp., formerly known as TXU Corp., is the parent comapny of several regulated and unregulated power generation and transmission businesses. $41.7B TOTAL INDEBTEDNESS EFH $1.9B $36.4B 3 TOTAL ASSETS TCEH $32.1B 1 EFIH $7.7B 2 MAJOR CREDITORS Apollo Global Management ($2.7B) Oaktree Capital Management ($2.7B) Centerbridge Partners ($1.4B) Avenue Capital Group York Capital Management GSO Capital Partners 1 Texas Competitve Energy Holdings, parent to Luminant & TXU Energy 2 Energy Future Intermediate Holdings, parent to Oncor, which is not included in the bankruptcy 3 Based on Decemeber 31, 2013 book value Source: Various motions filed by EFH in bankruptcy court, The Wall Street Journal & Bloomberg Did you know? In 2008, EFH sold 20 percent of Oncor to a group of foreign investors, including the Ontario pension fund in Canada and the investment arm of the Singapore government. The price tag was $1.3 billion. 28 EFH s collapse is the result of its bad bet on natural gas prices, which, in Texas, are closely aligned to wholesale electricity prices. In 2007, TXU s generating plants were greatly profiting because natural gas prices were near all-time highs. The buyout partners wagered natural gas prices would remain at those elevated levels or even increase. Instead, natural gas prices fell largely as a result of the recession that slowed industrial production and new exploration techniques that increased gas supplies worldwide. The drop led to a decline in EFH revenues, making the company s massive debt untenable. EFH has posted annual losses each year since Because of the state s electric deregulation law, investors as opposed to ratepayers should shoulder most of the financial risk from the EFH collapse. However it is unlikely that such a debt-heavy buyout would have occurred in the first place in the absence of deregulation. Warren Buffet, who invested $2 billion in EFH, called his own involvement a major unforced error. 5 EFH has filed for Chapter 11 bankruptcy protection in Delaware, which is the place of incorporation of 71 of the company s entities. Unsecured creditors, who stand to lose their entire investment under the proposed restructuring, have called unsuccessfully 6 for the proceedings to be moved to Dallas, noting that Texas is home to the company s assets, employees and customers. Delaware courts also have a reputation among critics for favoring lawyers for bankrupt companies over those of employees and creditors. 7 Lawyers for Energy Future Holdings have said the company could exit Chapter 11 within a year, although outside experts expect the proceedings to continue much longer. 8

4 P3 An Energy Future Holdings Bankruptcy Under EFH s reorganization plan, it would maintain a stake in Oncor, the transmission and distribution utility. 9 However, senior creditors would take possession of Luminant, the company s wholesale unit, and TXU Energy, the retail electric provider. In exchange, creditors would discharge $23 billion in debt, according to the proposal. 10 Did you know? In 2013, Oncor collected more than $432 million in profits, a more than 20 percent increase over 2012? 29 The bankruptcy could have important implications for the company s three lines of business and their customers: LUMINANT, the wholesale generation company, owns more than 15,000 megawatts of coal, nuclear and natural-gas fired generating plants. 11 The Public Utility Commission of Texas ( PUC ) found in 2004 that this fleet is so massive that its operators may have the ability to unilaterally impact prices whether they intend to do so or not. 12 If this fleet is eventually sold in its entirety to a single entity, then that market power could grow. This would be a step backwards for competition and could eventually contribute to higher prices. By contrast, breaking up the Luminant fleet could lead to a more competitive market. Luminant also is the state s No. 1 lignite coal miner, with annual production of more than 30 million tons. Fitch Ratings, a debt rating agency, estimates Luminant s value at $12.9 billion. 13 AEP Texas Central AEP Texas North CenterPoint Energy Oncor Texas-New Mexico Power Company ONCOR, the regulated transmission and distribution service provider (TDSP) overseen by the PUC, serves customers at more than 3 million meters. 14 Both in terms of geographic area and number of meters served, it is the largest of the four regulated TDSPs in Texas. The company is financially healthy, and it is important for ratepayers that it remains so. In 2007, after negotiations with cities and other interested parties, the buyout partners agreed to a number of complicated legal covenants intended to financially shield Oncor and its ratepayers in the case of an EFH bankruptcy. Oncor could eventually be sold as a unit to another transmission and distribution company, such as Sharyland Utilities, owned by members of the Ray Hunt Family. 15 Foreign investors already own 20 percent of Oncor, and could attempt to acquire more. The impact of such a transaction remains unknown. Oncor is not a party to the bankruptcy, but its corporate parent is. Fitch Ratings has valued Oncor at about $9.4 billion. 16 TXU ENERGY, serving more than 1.7 million end-use customers, is the state s largest retail electric provider. 17 As a standalone unit, it remains profitable. TXU s size and recognizable brand should make the company attractive to would-be buyers, according to analysts. 18 Fitch Ratings has valued it at $2.5 billion. 19

5 P4 An Energy Future Holdings Bankruptcy? The Owners Energy Future Holdings was born in 2007 the product of a debt-heavy buyout of TXU Corp., the Dallas-based energy giant. The purchasers were New York-based Kohlberg Kravis Roberts, Texas-based TPG Capital, and the private equity arm of New York investment bank Goldman Sachs. The new board of directors was chaired by Donald Evans, who previously served as U.S. Secretary of Commerce under President George W. Bush. 20 After the acquisition of TXU Corp., the buyers changed its name to Energy Future Holdings. Energy Future Holdings: A Timeline 2007 The TXU board agrees to sell the company to investors led by Kohlberg Kravis Roberts & Co. and Texas Pacific Group for about $32 billion and the assumption of about $13 billion in debt. The buyout closes in October. The company is renamed Energy Future Holdings Natural gas prices in July reach $13.58 per million British thermal units, the highest price since the buyout. By December natural gas was selling for less than half that much. 22 This impacted EFH s ability to pay off its newly acquired debt. The company reports a net loss of $8.9 billion for the fourth quarter Attempts to slash $2 billion from its debt meets with little success. EFH offers some bondholders 67 cents on the dollar, but few take the deal. In September, natural gas prices fall to $2.843 per million Btu, less than a fourth the price recorded a year earlier In July EFH exchanges bonds for between 72 and 79 cents on the dollar to cut debt by $900 million. In October, EFH reduces the value of the company on its balance sheet by $4 billion Natural gas prices continue to fall, and hit $2.2 per million Btu in April, their lowest mark since the buyout. 25 EFH reports its sixth consecutive quarter of declining revenues 26 and announces it will terminate pensions for those working for competitive holdings. 27 However, executives get millions of dollars in incentive bonuses, with chief executive John Young receiving $6 million EFH begins discussing a bankruptcy plan with some of its largest creditors that would result in most equity going to senior lenders On April 29th, EFH files for Chapter 11 bankruptcy protections in a court in Delaware, the corporate home of some of EFH s companies.

6 P5 An Energy Future Holdings Bankruptcy End Notes 1 2 Big gamble felled Energy Future Holdings. Safe bet could resuscitate it, Ken Silverstein, Christian Science Monitor, May 2, Energy Future Holdings press release, online at 4 Energy Future Holdings Could Avoid Paying Taxes on $23 Billion, Nicholas Sakelaris, Dallas Business Journal, Apr. 3, Id. 6 Energy Future Bankruptcy to Remain in Delaware, Peg Brickley, Wall Street Journal, May 22, Delaware messes with Texas, sparks fight over mega-bankruptcy, Tom Hals and Nick Brown, Reuters, April 29, Luminant website, 12 PUC: North Texas Utility TXU May Be Too Dominant, R.A. Dyer, Fort Worth Star-Telegram, Jan. 29, Oncor website, 15 Sale of Oncor Might be Powerful Draw, James Osborne, Dallas Morning News, Mar. 4, Energy Future Holdings press release, online at KKR s $45 Billion 2007 LBO Energy Future Holdings May Now Be Close to Bankruptcy, Clive Minchom, Jewish Business News, Feb. 22, It s Buyout Completed, TXU goes Private under New Name, Associated Press, Oct. 11, Monthly NYMEX Reports. 23 Energy Future Holdings Reports Fourth Quarter and Full Year 2009 Results, Business Wire, Feb. 19, Monthly NYMEX Reports. 25 NYMEX Exchange. 26 Dark Days for EFH Owners, Elizabeth Souder, Dallas Morning News, May 27, Sorting Out All The Pieces, Elizabeth Souder, Dallas Morning News, Oct. 7, Id. 29 Sale of Oncor Might Be Powerful Draw, James Osborne, Dallas Morning News, Mar. 4, Id. About the Texas Coalition for Affordable Power TCAP is a coalition of more than 165 cities and other political subdivisions that purchase electricity in the deregulated market for their own governmental use. Because high energy costs can impact municipal budgets and the ability to fund essential services, TCAP, as part of its mission, actively promotes affordable energy policies. High energy prices also place a burden on local businesses and home consumers.