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"Reliant Energy will reduce the size of its Texas retail electric business by changing how it manages risk and reducing the number of business customers it serves as it contends with the ongoing credit industry crunch and a roller-coaster year in local power markets.
In a conference call Tuesday with analysts and investors, Reliant officials said the retailer, the state's largest by power delivered, has to find ways to cut the amount of collateral required to run its retail business.
About 70 percent of the company's profits come from residential customers, but 70 percent of the money it needs to post as collateral for wholesale power purchases is for the customers in Reliant's commercial and industrial segment.
Chief Operating Officer Brian Landrum said the company spends $7 billion a year for the power it sells to customers. But it is required by its power suppliers to have lines of credit that can cover the changing price on up to 450 billion cubic feet of natural gas — a power plant fuel that essentially drives wholesale electricity prices.
Since commercial customers generally have longer-term contracts, the company's exposure to natural gas price swings can be tougher to manage in those accounts.
"We need to lower the capital requirements of the business in light of the dramatic increase recently in the cost of credit," Landrum said. "We will focus on building those parts of the business that use the least capital to generate the highest return."
Residential customers won't see changes in their existing contracts with Reliant, company spokeswoman Pat Hammond said.
But renewing commercial customers may have to accept shorter-term contracts or deals structured so they bear more of the risk from changing commodity prices.
Shares of Reliant fell $2.73 to $7.35 on Tuesday, a 27 percent drop, which was the company's biggest since July 2002, when investors dumped the stock amid concern the company might run short of cash. Reliant has lost more than half of its stock value since Sept. 15.
Reliant operates nearly 15,000 megawatts of power plants in nine states where it produces power for the wholesale market.
On Monday, Reliant said it was cutting its 2008 revenue projections by about $800 million, with as much as $350 million coming out of the retail business and $480 million from the wholesale business.
On the retail side about $200 million is directly related to Hurricane Ike, including the reduction in customer power purchases because of widespread power outages in the Houston area, Landrum said.
He attributed another $100 million in reduced revenue projections to wholesale prices the company locked in last spring when natural gas prices were higher than they are now, and to cooler August weather that reduced demand for power to run air conditioning.
Many retail electric providers try to hedge against changing wholesale prices through futures contracts, but can lose money if spot prices turn out to be lower at the time the contracts come due.
The company said Monday it was terminating a credit agreement with Merrill Lynch that it had used to backstop much of the power purchases for its retail business, replacing that line of credit with a $650 million loan from Goldman Sachs and a $350 million equity investment from First Reserve on terms much more costly than the agreement with Merrill.
"I would certainly acknowledge that it was not an ideal time to raise money in the capital markets and it was expensive to do that," Reliant Chief Executive Mark Jacobs said in Tuesday's conference call.
The year 2008 has also been particularly rough for Texas electric retailers.
Wholesale power prices rose sharply in the first half of the year because of a run-up in the price of natural gas, Texas' main generation fuel. Some companies failed to hedge properly against those increases through long-term wholesale contracts.
The wholesale market also saw a number of price spikes in April, May and June mainly because of weaknesses in how the state's main grid operator managed congestion on its power lines. Those spikes sent some cash-strapped companies scrambling to meet financial obligations to the grid operator. Five retailers went out of business. A few others sold their customers to larger rivals.
Reliant was already struggling with difficulties in its retail business this year but a $4 to $5 drop in the price of natural gas in recent months, combined with Hurricane Ike, led to the actions this week."