Destec Energy, Inc.

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Destec Energy, Inc.

P.O. Box 4411
Houston, Texas 77210–4411
U.S.A.
(713) 735–4000
Fax: (713) 735–4201

Public Company
Incorporated: 1989
Employees: 610
Sales: $727 million
Stock Exchanges: New York
SICs: 4931 Electric and Other Services Combined

A subsidiary of The Dow Chemical Company, Destec Energy, Inc. is a leading U.S. independent power producer and a major player in the emerging independent power industry. Through its ownership interests in power generation and coal–gasification facilities, Destec’s power production capacity in 1994 was about 2,400 megawatts of electricity and three million pounds per hour of steam. Destec has grown rapidly since its inception in 1989.

Dow’s formation of Destec in 1989 reflected its desire to capitalize on growth occurring in the market for cogeneration and alternative energy provided by private companies. Cogeneration is a power production technology that provides the sequential generation of two or more useful forms of energy, such as electricity and steam, from a single fuel source, such as natural gas or coal. Destec’s principal power production technologies are gas–fired cogeneration and coal gasification, the latter being a process in which coal is converted into syngas, an alternate energy source. Destec uses those technologies to generate three primary products: electricity, thermal energy, and syngas.

Strong demand growth in the 1980s and early 1990s for alternative power sources was largely the result of federal government initiatives. Between the 1930s and the late 1970s, production, transmission, and distribution of electric power was relegated exclusively to vertically integrated, monopolistic, government–regulated utilities. The industry was governed by the Public Utility Holding Company Act (PUHCA) of 1935, which essentially barred non–utilities from participating in the generation (and distribution) of power. When the oil crises of the late 1970s arose, however, Congress passed the industry–renowned Public Utilities Regulatory Policies Act of 1978 (PURPA).

PURPA was created to encourage the production of power from alternative (non–oil or coal generated) sources. Utilities were required by this federal law to purchase power from new “qualifying facilities,” if these facilities could produce the power at a cost equal to or less than those facilities that the utilities could build themselves. While the law was originally intended to reduce U.S. utilities’ reliance on oil, it ultimately resulted in the creation of a healthy market for nonutility power generators (NUGs), like Destec. Under PURPA, Destec’s facilities would have to meet at least one of two specified conditions: they would have to generate less than 80 megawatts of power, a small amount in comparison to some large utility generators, or, they would have to cogenerate. Destec’s units would still be susceptible to federal price controls, but they would be free from stricter state price caps applied to the utility companies that would purchase Destec’s power.

Although Dow created Destec in 1989, it had already been active in the cogeneration industry for several years. In fact, Dow was considered a pioneer in U.S. cogeneration. Dow’s founder, Herbert H. Dow, generated electricity and steam from wood in the late 1880s. During the 1900s, Dow used the efficiency of cogeneration to supply power to its own factories, thus giving its products a strong cost advantage over competing goods. Dow didn’t enter the cogeneration market until it formed Destec. However, Dow’s early efforts at its own facilities were important in demonstrating that cogeneration was a reliable and cost–effective means of producing energy.

During this time, a company that would figure prominently in Destec’s future was preparing for expansion. PSE, Inc., a pioneer in the cogeneration industry, was founded in 1969 by Albert Smith Jr. and Tom McMichael, and the company had remained private until the 1980s. In an effort to raise capital for expansion, PSE went public in 1986 and subsequently became engaged in several new cogeneration projects. However, its growth continued to be hampered by a lack of capital.

Following the passage of PURPA, PSE built CoGen Power in 1983, a cogeneration facility in Port Arthur, Texas, that had a production capacity of only five megawatts of electricity and 550,000 pounds of steam per hour. The small plant sold its steam to Chevron, while both the Great Lakes Carbon Corporation and the Gulf States Utilities Co. purchased the electricity. PSE’s first project was the Salt Grass cogeneration unit it built at Dow’s Texas division in 1969 (before PURPA). That successful experiment served as a stepping stone to a string of much larger facilities that PSE would construct throughout the 1980s and early 1990s. In 1985, CoGen Lyondell went on line in Channel view, Texas. That large cogeneration facility eventually had an electric capacity of 465 megawatts and 1.15 million pounds of steam per hour. As lessee of the plant, PSE supplied power to the giant Texas Utilities Electric Company, and Lyondell remained Destec’s largest facility going into the mid–1990s.

In 1987, Dow opened its third power plant, as a result of the U.S. Treasury Department’s Synfuels Corporation, which promoted alternative technology: the Louisiana Gasification Technology, Inc. (LGTI) facility in Plaquemine, Louisiana. Designed and built by Dow, LGTI was a coal–gasification facility capable of churning out enough syngas to fuel the production of 160 megawatts of electricity. LGTI was the first of two coal–gasification plants that Dow would open by the mid–1990s and was developed in part as an experiment, supported by the federal government, to determine the viability of the new process. Dow itself used the syngas supplied by LGTI.

In 1988, PSE helped to open the Corona cogeneration facility in Corona, California. PSE was a partner with several other investors in that project, which supplied electricity to a California utility and steam to a local food processing company. Early in 1989, PSE opened three more facilities in Kern, California, that were similar to Corona. PSE owned about 20 percent of those cogeneration plants, each of which could produce 48 megawatts of electricity and 100,000 pounds of steam per hour. They supplied electricity to Pacific Gas and Electric Company, a major utility, and steam to Occidental Petroleum Corporation.

By 1989, PSE owned or operated seven cogeneration plants, while Dow owned and operated one coal–gasification facility. The combined capacity of those units was over 500 megawatts of electricity and more than one million pounds of steam per hour. Dow believed that the industry offered excellent growth potential. Indeed, by 1989, independent power producers like PSE were already supplying about 20 percent of the nation’s electricity. And energy analysts projected the figure to surpass 40 percent by the mid–1990s.

Signaling its commitment to the growing cogeneration industry, Dow created Destec as a separate subsidiary under which many of its energy operations were organized. The chief impetus behind the formation of Destec was Charles F. Goff, who had joined Dow in 1966 and had worked in a variety of manufacturing and management positions. In 1986, Goff was named manager of energy resources, and he became director of mergers and acquisitions in 1988. Experience at Dow convinced him that the company would benefit by creating a separate subsidiary to sell power to other companies. Dow took his advice and asked Goff to serve as president of the newly formed Destec.

Goff’s first move at Destec, with Dow’s help, was to acquire PSE, Inc., the independent power producer, which by this time was reporting about $230 million in annual sales but was still hampered by a lack of capital. Recognizing PSE’s potential, Goff arranged for the acquisition of PSE late in 1989. In 1991, Destec conducted an initial public offering, in which about 28 percent of the outstanding shares in Destec were sold for $260 million.

Destec entered the 1990s as one of the largest companies in the fast–growing independent power industry. It was also among the companies best situated for growth. Destec benefited from a strong foothold in the chemical and petroleum markets for inexpensive power, and it had access to a reserve of expansion capital through its initial public offering. Furthermore, most of its existing cogeneration plants were engaged in long–term contracts that assured steady cash flow at least through 1994. Backed by those credentials, Goff and fellow executive Robert McFedries, Destec’s chairperson, launched an aggressive growth initiative in 1990.

Destec participated in the construction and operation of two new cogeneration plants that came on line in 1990: the San Joaquin and Chalk Cliff facilities, both of which were located in California and supplied most of their output to Pacific Gas and Electric. In 1991 and 1992, Destec tagged three more cogeneration facilities onto its operating project list: Badger Creek, McKittrick, and Live Oak. All three of these cogeneration plants were 50 percent owned by Destec. Located in Bakers–field, California, they also supplied energy to Pacific Gas and Electric and sold the steam to various corporations. Like most of Destec’s other California facilities, the three plants each had an electricity capacity of about 45 to 50 megawatts.

Also in 1992, Destec completed one of its largest projects, the Commonwealth Atlantic plant in Virginia. That facility was Destec’s first to begin operating following the enactment of new federal laws that further diminished government requirements for independent power producers. In fact, the plant was not a cogenerator; it could produce 340 megawatts of electricity but no steam. Destec owned 50 percent of the facility. In 1993, Destec acquired a 50 percent interest in another plant, the Black Mountain facility, in Las Vegas.

By the end of 1993, Destec had interests in 14 different projects with a combined generating capacity of more than 1,300 megawatts of electricity and about two million pounds per hour of steam. It was also marketing about 425 megawatts of power cogenerated by Dow Chemical. Furthermore, Destec boasted owned reserves of over 100 billion cubic feet of natural gas. As Destec’s capacity expanded, sales shot up to more than $500 million in 1991 and then to $673 million in 1993, despite a U.S. recession. Likewise, net income bounded to more than $80 million in 1991 and then to more than $100 million in 1993. Destec’s future looked bright as it entered 1994. It had the equivalent of 1,200 megawatts of new facilities under construction and another 673 megawatts on the drawing board.

Part of Destec’s success during the early 1990s was attributable to favorable markets. Since 1990 about 50 percent of all new power generation capacity in the U.S. had been supplied by independents, and the trend was expected to continue. But Destec’s gains were also a corollary of savvy management strategies. For example, Destec differed from its industry peers in that it maintained a large engineering staff to design its facilities. Its integrated structure allowed it to profit where other companies couldn’t. Furthermore, Destec’s affiliation with Dow gave it access to Dow plant sites and global markets.

Despite its seemingly strong competitive position, however, Destec began to encounter some problems in 1994. Importantly, two ten–year power supply contracts with Texas’s largest investor–owned utilities expired. In 1993, Destec garnered about one–third of its sales and nearly three–fourths of its profits from contracts related to the power it produced or marketed in Texas. One of those contracts, for power supplied by CoGen Lyondell, ran out April 30, 1994, leaving Destec without a long–term customer to buy the power. Furthermore, two other contracts for Destec’s Texas power were set to expire December 31, 1994 and April 30, 1995. According to some analysts, the problem was exacerbated by a glut of power in the region, which some expected to significantly reduce any new contract rate that Destec might negotiate.

Mostly as a result of its looming Texas problems, Destec’s stock price tumbled 23 percent during 1994. Although net income increased, worried investors registered their concerns on Wall Street. Goff therefore adopted a new strategy. He decided to deemphasize the company’s vertical integration by downsizing its large engineering and design staff; those layoffs would come as part of a $9.5 million restructuring effort. Most important, Goff announced plans to emphasize global expansion, particularly into high–growth developing regions such as Latin America and Asia.

As Destec regrouped in 1994 and 1995, it sustained its aggressive growth program. The company brought two major plants under its wing in 1994, in which it had a 50 percent interest: Hartwell Energy Project, a 300 megawatt gas–fired plant in Georgia, and the Oyster Creek cogenerator in Texas, which had a capacity of 424 megawatts of electricity and 1.1 million pounds of steam per hour. In January 1995, the company brought on line Tiger Bay, a 212 megawatt gas–fired cogenerator, in which it held a 50 percent share. That year, Destec planned to open a new California cogenerator, Bear Mountain, which it owned in partnership with the Consolidated Natural Gas Company. Other Destec openings in 1995 were also expected to include a 262 megawatt–equivalent coal–gasification facility and a 123 megawatt cogeneration project, Michigan Power, in Ludington, Michigan.

Furthermore, Destec was in the process of developing seven more plants, scheduled to open in 1996 and 1997. Those facilities, combined with the new plants opened in 1994 and 1995, would bring the total electricity producing capacity of Destec’s facilities to more than 5,000 megawatts and the steam producing capacity to nearly five million pounds per hour. Among the largest of those facilities was Terneuzen, a cogeneration plant in the Netherlands, scheduled for completion in 1997. That project represented Destec’s first overseas venture. Despite minor setbacks in 1994, healthy long–term market projections combined with Destec’s strong balance sheet suggested a long–term industry presence for the independent.