Steam Heat : Test of Wills Between 2 Geothermal Firms Could Get Even Hotter

As the takeover battle between the nation’s two largest geothermal companies continues to escalate, California Energy Co. will probably have to boost its offer for Magma Power Co. to more than $1 billion if its hostile bid is going to succeed, analysts say.

At issue is the proposed union of two little-known but prosperous geothermal companies, the largest survivors of a government-sponsored effort that began in the late 1970s as an effort to foster the growth of “alternative energy” companies that harness wind, solar and steam power for profit.

The contest has been a test of wills between an aggressive company from Nebraska with a California name and a staid utility in San Diego with strong ties to Dow Chemical. The fight has also put a spotlight on changes sweeping the entire electric power industry.

Utilities are going down the same path toward deregulation and free-market competition as trucking, airlines and other once-protected U.S. industries. Power companies large and small could soon be competing for customers, who ultimately will be able to shop around for the best electricity and gas rates.

And because current fossil fuel-generated power costs less than half what geothermal does to produce, and because government-mandated subsidies for alternative energy producers are slowly melting away, geothermal companies face a bleak future in the United States, despite the enormous technological advances made by Magma Power and others.

Despite that, the $840 million California Energy has offered for Magma shows there is life yet left in the geothermal industry in overseas markets such as the Philippines, where fossil fuels are scarce, and Indonesia, where they are exported to generate foreign currency.

Indonesia alone is expected to build 3,000 megawatts of geothermal generating capacity over the next decade--as much as currently exists in the United States, according to Kidder Peabody geothermal expert Bill Short. And both California Energy and Magma Power expect to play strong roles in developing that power.

“For every unit of opportunity for geothermal domestically, you have 10 units internationally,” Short said.

The exploitation of overseas markets was a major factor in California Energy’s proposal to buy Magma Power for $35 a share in cash and stock. By combining, the two companies could compete more efficiently, California Energy Chairman David Sokol said when the offer was announced.

Since then, the battle has heated up steadily. Magma Power’s board formally rejected the unsolicited offer and advised shareholders to turn a deaf ear to its suitor. Last week, California Energy stepped up the pace by initiating a proxy fight that would force a special shareholders meeting at which it could present its case directly to Magma investors.

On Monday, the two companies traded lawsuits in federal court in Nevada, where Magma is incorporated. California Energy accused Magma Power of violating its fiduciary responsibilities to shareholders, while Magma Power accused California Energy of violating disclosure laws relating to its proposed acquisition and proxy solicitation.

Magma Power, which runs seven geothermal plants in the Imperial Valley that generate enough power to light a city of 250,000 people, is also taking its case directly to Wall Street and large investors, saying it is worth more than $840 million, mainly because of its international prospects.

Many financial analysts, including UBS Securities’ Daniele Seitz, say California Energy will probably have to bump its offer to $40 a share if its tender offer is to succeed. “At this point, shareholders see this as an underwhelming bid, a bit shy,” Seitz said. “They are waiting to see whether California Energy means business.”

Sokol said in an interview that his company “won’t go to $40. . . . But we’ve been willing since Sept. 19 to sit down and negotiate all terms of our proposal.”

California Energy moved its headquarters from San Francisco to Omaha in 1991, in part to be near its largest shareholder, general contractor Peter Kiewit & Sons, which owns a 43% stake. Because its six energy plants are in the Mammoth and Yuma areas, the company retained California in its name.

Magma Power is 21%-owned by Dow Chemical, whose engineers helped the company solve the riddle of harnessing superheated brines, which flow in subterranean currents a mile below the Imperial Valley at temperatures of 550 degrees Fahrenheit.

Though Dow has lowered its stake in Magma from 41% two years ago, the two companies maintain strong links. Several of Magma Power’s current and past executives, including Chief Executive Ralph Boeker, are former Dow Chemical executives.

Both California Energy and Magma Power are highly profitable, thanks in part to the federal and state subsidies for alternative energy companies in the 1970s. The government’s goal was to reduce a dependency on foreign oil and to foster environmentally clean power.

New laws mandated that utilities such as Southern California Edison sign contracts of up to 30 years to buy geothermal, wind and solar energy, paying the projected cost of fossil fuel power. Over the initial 10 years, utilities were to pay at a fixed rate based on the hypothetical cost of a barrel of oil, which was projected to rise as high as $40.

Instead of rising, the price of fossil fuel declined to about $17 a barrel level, the current price. Now, as the 10-year fixed-price periods are ending, the contracts with geothermal producers are being repriced to reflect actual power costs. The result will be a dramatic drop in revenue for Magma and others.

For example, Southern California Edison is now paying producers such as Magma about 11 cents per kilowatt-hour for its geothermal power. If the contracts were adjusted today to reflect the cost of natural gas, the price to Magma would drop to about 2.7 cents, according to Don Fellows, manager of non-utility power purchases for Edison.

Magma Power can now produce power at about 5.7 cents a kilowatt-hour, Boeker said. But that’s still about twice the cost of power produced by natural gas.

“Because of the low price of natural gas, we haven’t been able to do anything,” said David N. Anderson, executive director of Geothermal Resources Council, a trade association of geothermal companies based in Davis, Calif. “We’re not bringing in anyone new into the business. Jobs are not growing.”

According to Anderson, the number of U.S. geothermal developers and producers has dropped to 10 from more than 25 in the late 1970s.

But the geothermal energy industry is not going to disappear, said Jan Hamrin, a principal in the environmental consulting firm Hansen McOuat Hamrin & Rhode in San Francisco.

“There is a national interest in ensuring that geothermal survives, in structuring a new utility industry that brings down electric rates but which hedges against future risks of escalating oil prices,” Hamrin said.

Geothermal Profit

California Energy and Magma Power are two little-known, but highly profitable, geothermal companies now locked in an increasing bitter takeover battle. The firms are the largest survivors of a government-sponsored effort that began in the 1970s to foster the growth of “alternative energy” companies.

MAGMA POWER CO.

Revenue, in millions:

1994*: $73.5

Earnings, in millions:

1994*: $24.0

CALIFORNIA ENERGY CO.

Revenue, in millions:

1994*: $80.7

Earnings, in millions:

1994: $15.0

The Fight for Magma Power

* Sept. 19, 1994: California Energy Co. proposes to acquire Magma Power for $840 million in cash and stock.

* Sept. 22: Magma Power Co. retains Goldman Sachs and Sherman & Sterling as independent financial and legal advisers.

* Oct. 3: Magma Power adopts a “poison pill” stockholder rights plan and files suit in Nevada, where it is incorporated, seeking a judgment that a merger would violate state law.

* Oct. 6: California Energy commences what it describes as the first phase of its tender offer, offering to buy the first 51% of Magma Power shares for $35 each in cash.

* Oct. 10: Magma Power’s board says the offer is inadequate, coercive and opportunistic. It recommends that shareholders reject the offer.

* Oct. 11: Magma Power discloses it signed “golden parachute” agreements with 15 of its executives on Sept. 15, four days before California Energy’s initial offer. The timing was coincidental, Magma says.

* Oct. 13: California Energy launches a proxy fight to elect four new directors and force a special shareholders meeting to present its takeover bid to Magma Power investors.

* Oct. 14: California Energy files suit in state court in Nevada to obtain Magma Power’s shareholder list.

* Oct. 17: California Energy files suit in federal court in Nevada charging Magma Power with breach of fiduciary duty for taking “obstructionist actions” to block a merger. Magma files a suit of its own alleging that California Energy violated federal securities laws.