Dynegy Inc. caught the gas and power convergence wave early on and is now engaged in power generation; and marketing, gathering, processing, and transportation of energy. The company on Aug. 8 reported it will purchase 1700 Mw in the Northeast US. It is entering the telecom and broadband market through the purchase of Extant Inc. The company reported a banner second quarter. Earning were a record 58 cents, up from 25 cents in the 1999 comparable period. Second quarter earnings beat Wall Street’s consensus estimate by 5 cents.
Oil & Gas Journal Online Power Editor Kate Thomas on July 17 interviewed Steve Bergstrom, president of Dynegy Inc. about the evolving energy marketplace and Dynegy’s role in it.
OGJ Online: As a merchant energy company operating in California, what’s your take on the problems in that market?
Bergstrom: A couple of things have changed pretty significantly since last year. Temperatures were pretty mild last year. This year is warmer than normal so far. Also, hydroelectric is a lot lower this year than last year.
Last year hydro was running 120% of normal snow pack. This year it is running about 95% of normal. People are not letting water go out of any reservoir. Nobody knows how long this will last.
Demand has grown tremendously. It grew about 80% last year to this year.
OGJ Online: What can be done to solve California’s problems?
Bergstrom: We have been fighting the price cap this year. We thinks it masks the signals needed to tell people to go build new generation. Look at the Midwest, for example, where there are no price caps. They had price spikes in 1998, and you saw a whole bunch of new plants get built. Now you have new plants coming on line all over the Midwest, so you had a supply and demand reaction.
OGJ Online: What’s different about California?
Bergstrom: The problem in California is, every time the price moves up, it signals someone to build power plants, [but] there is an intervention. Some politician, regulator, or the ISO [Independent System Operator] comes in and tries to regulate the price.
That just prolongs the problem, because the market is telling you, “I’m short,” and you can go build generation. But yet, when someone comes in and puts caps on it, it just delays and takes a lot of time to fix the problem.
We told them that in ’98, the first time they put the caps on: “This is going to come back and bite you.” It has. We told them that again this time.
OGJ Online: What would you like to see happen?
Bergstrom: The concern we have in that state is that we have had an ISO in operation for 26 months or something like that, and we have had 29 tariff changes. That’s not a whole lot of stability for a generator to go in and put a 30-year investment on the ground. It can cause some heartburn.
We are trying to get them to be a little more understanding with regard to expedited permitting of plants. Permitting of plants in that state is difficult.
The good thing that can come of this is that it has increased awareness of the need for generation. We are hoping we can repower some existing assets, and hopefully we can get some expedited treatment of that. Then we can actually help solve the underlying problem, which is more demand than we have supply.
OGJ Online: Dynegy has set a goal of having about 15% of the wholesale US power market. How is that coming?
Bergstrom: Actually it’s about 70,000 Mw, which should be around 10-12%-owned and controlled generation-by 2004. We are about one third of the way there. We have about 25,000 Mw under our control, a combination of what we own or what we contract for, so we are right on track at this point.
OGJ Online: How did you come up with that number?
Bergstrom: It is about the size we are in gas. We set a goal and target to get a similar market share in power. It gives us something to shoot for.
OGJ Online: How do you expect to achieve your market share goals in electricity?
Bergstrom: We have an active group contracting for capacity. Most of the greenfield generation we are building is peaking. Most of the contract stuff we are buying is more base load combined-cycle because that is what the developers are building-the Calpines, the AES’s, and guys like that.
Acquisitions kind of vary from base load coal to intermediate gas. We are not really looking at gas peakers as acquisitions. Most of the gas peaking we are looking at are greenfield sites. The way this market is setting up-and it also depends on what your forecast is for gas prices-the market is still short of peaking capacity.
OGJ Online: Now that you are in the transmission system business through Illinova Power, how is the transmission system holding up?
Bergstrom: Illinois is seeing more load on their transmission system than ever. Illinova actually lost a 345 kv line when I was there last week because it actually sagged more than it had ever sagged before. We are really having a hard time getting power moved around.
I think utilities are being very conservative on trying to control everything in their control area. They are so worried about things happening. We see more and more the need to redo the transmission system. The interconnectivity between the grid is not working. In fact, it’s worse this year than it was the last 2 years.
OGJ Online: What’s the answer?
Bergstrom: To make this market really work, we need to have that transmission grid working a lot better. We need some expansion, we need some capacity additions. I think we are starting to get focused on that. Of course, it is hard to get environmentalists on the side of doing that. But at the end of the day, something has got to give. You cannot continue to grow demand without doing something about the supply side of the transmission system.
That was a big part of the problem [in California] in May and June. You could have had more generation, but they couldn’t get it where it was needed because the transmission system was too constrained. New York City [also] has transmission and distribution constraints.
People don’t like transmission lines. There are still people out there worried that transmission lines cause cancer, or it’s an eyesore and degrades property value. And what you get for right-of-way is nothing compared to what you get for a plant on a site [if you are] a landowner.
OGJ Online: What is Dynegy’s preference among regional transmission systems, transcos, and the like?
Bergstrom: We would like to see a for-profit transco, because we think the utilities need incentives to build transmission. That’s part of the problem in California. You look at it and say, “Who is supposed to build transmission?” The ISO says, “It’s not our job. We are supposed to be like an air traffic controller making sure all the load gets matched.” The utilities say, “It’s not our job because we don’t control this stuff anymore.” So who has the economic incentive?
A lot of these guys have frozen rates. If you have frozen rates, the last thing you want to do is add capital expansion because you are not going to get to recover on it. Some of this stuff has created this box we are in. There is nobody with any economic incentive to really solve the problem.
OGJ Online: Where do we go from here?
Bergstrom: One of the things we think could solve the problem is contributing the transmission and distribution system to a for-profit transco. The more power they move, the more money they make. They actually have some incentive to solve the problem. Today there isn’t [any]. Today it’s just a hassle for them to move more power.
One of the issues we keep hammering on is that we don’t think you can have a competitive retail market until you get the wholesale market truly competitive and efficient. And we think the first step is to solve this transmission stuff.
OGJ Online: What’s the problem in the wholesale market?
Bergstrom: A lot of these states have tried customer choice at the retail level, but without a competitive wholesale market it’s too dangerous. I wouldn’t want to send a customer out into this market as volatile as it is. That’s just not good at all for the health of the industry. As a result, even though we have had choice in Illinois since Oct. 1 for large customers, nobody has participated because rates are frozen at the utility. They are insulated from all this stuff.
And, if you are a CEO of an industrial company and one of your guys comes to you and says, “Look, I want to go out and buy power from a third party,” [you ask,] “What’s the range of power been in the last year?” [And the answer is] “Well it’s gone from $25 to $10,000 [per Mw-hr], but don’t worry, I can manage that,” vs. buying from a utility that has frozen rates and will give you whatever you want on demand at a flat rate. It’s a no brainer.
OGJ Online: How many of your merchant plants are up and running?
Bergstrom: Calcasieu is running. Rockingham Units 1-4 are running. Unit 5 has been running since the first week of July. It’s been generating 600 Mw for Duke every day. They have been calling on it. It’s been real hot in the Southeast [US]. Duke has been calling on it quite regularly. There is more than 1100 Mw coming on line next summer.
OGJ Online: What effect is the price cap movement having on generators such as Dynegy?
Bergstrom: If you really drill into the price caps, it’s really a lot of to-do about nothing. First, it is not an energy price cap, it’s an ancillary services price cap. Energy prices are basically market prices. The one in New York was an ancillary services price cap. So is the one in California.
On most of our pro formas for our plants, we don’t assume any value for ancillary services like spinning reserves. As a generator, people pay you for running your plant at a turned-down level so that at a moment’s notice you can turn it up. If you are within 2% of the next hour, that’s pretty good. You always need some generator there holding spinning reserves so, if you have a demand, you can serve it instantaneously. That’s where most of the caps are coming from.
We don’t think it is going to spread nationally. We really think it is transitional trend that FERC is giving the ISO.
OGJ Online: What is your outlook for natural gas?
Bergstrom: Supply will be tight, and prices will be strong. But I think the market will be served. People will figure out a way to be more efficient.
I think there will be plenty of gas in storage for peak months. The shoulder months will be a little bit more volatile, like November and March. Whereas people would lean on storage going into and coming out of winter, they are going to have to manage the business a little differently than they have before.
We still have a pretty good response from the production side. The rig count is over 900, and two thirds of that is gas. Delivery is picking up behind the supply system. This is the way markets ought to work.
I don’t know how sustainable $4 gas is. It wouldn’t surprise me to see it drop to $2.50-$3.00.
OGJ Online: Dynegy disposed of its oil business recently. Why is that?
Bergstrom: We’re not big enough to make an impact. The oil business is declining in the US. We would rather put our capital into growth businesses like power.
OGJ Online: What is the outlook for the rest of the year?
Bergstrom: We are having a really good year. We feel like all our businesses are doing well.
OGJ Online: Dynegy has engineered quite a turnaround in the last 2-3 years. How was it achieved?
Bergstrom: Maybe the worst thing that ever happened to us was the best thing that ever happened to us. The liquids business collapsed under our feet. The machine was not running as well as it should [have been]. It woke us up. We spent a huge amount of money fixing our processes. We had been a small company and never mapped our business processes.
It was a blessing in disguise. As a result, the Illinova merger was seamless. We could never have done that before. We have also done a better job of marketing to [Wall] Street. People are starting to understand Dynegy.
Steve Bergstrom is Dynegy president and chief operating officer with responsibility for day-to-day development and execution of the company’s strategy across its operating business units. He has been a member of Dynegy’s board since 1995. After joining Natural Gas Clearinghouse, Dynegy’s predecessor, in 1986 as vice-president, gas supply, Bergstrom was promoted to senior vice-president, gas marketing and supply, in 1987. He was named a director in 1995 and promoted to his current position in August 1999.