26 February 2007

The Intersection of Private Equity and Environmentalism

The largest leveraged buyout ever is taking place and it has a uniquely environmental twist to it. Two private equity firms, Kohlberg Kravis Roberts & Company and Texas Pacific Group, are working to buy TXU, a Texas utility company. The price on the table is currently $45 billion. Not a small chunk of change for a bunch of individuals to bring together.

Though the deal is certainly remarkable for being the scale of the numbers involved and it may be interesting to ponder the consequences of utilities being traded around by investors, the most remarkable aspect is the degree to which environmental groups have been involved in the negotiations. The New York Times has this analysis of the situation and Business Week has this to say, but basically the deal went like this; KKR and Texas Pacific thought that buying TXU would make a good investment. One complication, however, was that TXU has long been the bane of environmental organizations because of its heavy reliance on coal power plants and its plans to build more of them in the future. (Coal is the least efficient fuel when considering carbon dioxide emissions per unit of energy produced.) So, what did the private equity firms do? They brought environmental groups, specifically the NRDC and Environmental Defense, directly to the table and worked to find a solution that the environmental groups would agree too.

Here's the result, taken from Marc Gunther:
1. TXU will drop plans for eight of the 11 coal plants.
2. TXU will support federal legislation regulating carbon emissions.
3. TXU will form a “sustainable energy advisory board” whose members will include Ralph Cavanaugh of NRDC, who knows more about the utility business than anyone else in the environmental movement, and Jim Marston, head of Environmental Defense’s Texas office, which had filed a couple of lawsuits against TXU.
4. TXU says it will “adopt corporate governance and executive compensation programs that tie the operations and goals of the company to climate stewardship.” In other words, executives will be paid more if their operations emit less.

So this seems pretty amazing and forces you to wonder why the private equity firms had such an interest in getting into the good graces of environmental groups before buying this utility company. Well, personality surely had something to do with it. David Bonderman is the co-founder of Texas Pacific and has plenty of environmental sensibilities to his name, serving on the boards of the World Wildlife Fund, The Wilderness Society and other environmental organizations. William Reilly, the EPA administrator under George H. W. Bush and long time conservationist is an investor at Texas Pacific.

So, was it just that these guys with a tinge of green at the private equity firm felt bad about buying a utility company and tried to clean their consciences as best as they could? Maybe, but I wouldn't discount for a second the interest that these guys have in making fiscally sound investments. That is their job after all and they aren't going to do anything that is going to hurt the bottom line of their deals. It would seem, then, that the answer is that these guys realize the economic consequences of pollution and, specifically, global warming. One the one had there is the threat of constant litigation against environmental groups and on the other hand is the fact that eventually the US Congress is going to begin to limit greenhouse gas emissions. The bottom line is that being environmentally irresponsible is quickly becoming an inefficient way to operate a corporation.

This, to me, is a great sign and is exactly as environmental regulation should work. There should be no expectation that corporations will act in the interest of the environment on their own. Their primary obligation is to their shareholders, plain and simple, and whatever costs they can externalize they should and will. Thus, all of the environmentalists who get upset at the corporations themselves are misguided and wasting their breath screaming at corporations to change their ways. Only insofar as environmentally-sound behavior is in the interest of the corporations shareholders should the corporation be expected to behave as such. The second main obligation that corporation has is to follow government regulations. As a purely free market would offend our moral sensibilities (people buying and selling other people, contract killers hanging up their shingle next to the barber, 7 year-olds working 16 hours a day in a factory, etc...) it is the place of the government to look at the consequences of the market and constrain it where necessary. Since individual most corporations have no desire or interest in considering the environmental consequences of their actions it falls on the role of the government to do so. Furthermore, other groups of interested individuals can make it their objective to lobby the government for increased regulation and work to ensure that corporations are behaving according to the regulations.

In this case we see all of these aspects coming together in a way that pleases the shareholders of the corporation, the private investors buying the corporation, and the environmental groups concerned about the activities of the corporation, not to mention the people of the world who will suffer less as a result of the reduced emissions. All in all, I find this to be great news and I hope that a trend develops and continues. I would think that, given the noteworthy size of this deal, that other investors will have to take notice of the environmental aspect as well.


  1. unfrozencavemandad6:54 PM

    I think this is a very good and highly-visible example for the future. It will no doubt be two steps forward, one step back in this fight for the next couple decades because there will be people in power who don't want to do what is necessary for the environment. I always ask WWCD (What Would Cheney Do)? That said, I have a couple observations and questions:
    1. TXU will drop plans for eight of the 11 coal plants. So, what type of plants (if any) will replace them? Is it that they don't have the demand and don't need the plants? Will they buy from other energy producers?
    2. "So, was it just that these guys with a tinge of green at the private equity firm felt bad about buying a utility company and tried to clean their consciences as best as they could?" I think in the case of these guys, it is a resounding "YES". I believe there are others who will act in an offensively/defensively "green perspective" from positions of profitability, existing/future litigation, PR, corporate image, etc.
    3. Since I know nothing of the infrastructure, cost/investment, and the art of the possible in the energy business, it's easy for me to ask: Why don't first-world countries like Europe and the US clean-up their acts now (scrubbers on coal-fired palnts, no more trading of emission credits, alternative energy sources, etc) and giant emerging economies like China and India do the same? Is there some Kyoto-like way to get there?

    Overall, the article does provide a big step in the right direction and optimism for the future. Hey, AlGore won Best Documentary for "An Inconvenient Truth" at the Oscars last night.

    Gotta go -- see ya!

    UGH.....FIRE GOOD!!!

  2. ditto what the cold guy said, it looks like this is a model for future business as a new generation of environmentally conscious investors find a solution to the problem of merging corporate responsibility and environmentalism. It is just smart business to begin addressing the concerns of the planet in the decisions corporate investers and equity managers make. The companies that are on the forefront of environmental issues will be the success stories of the 21st Century.
    I found the beatboxing floutist far more entertaining though.