Armed with the lofty ambition of "Repowering America," Calpine Corp. of San Jose, California, aims to become the nation's largest independent power producer. Judging by its recent progress, the 17-year-old company's investors are hoping a rags-to-riches story is under way. In 1984, founder and current chairman Peter Cartwright looked into the future and saw California's demand for energy spiraling upward as the population was on a steady rise, and he saw no way for the state to meet its projected power needs. Cartwright and four colleagues opened an energy consulting firm, carefully monitoring the progress of utility deregulation. A few years later, the group saw an opportunity to enter this new market by purchasing a one-megawatt interest in a small geothermal facility in northern California. Today, publicly traded Calpine (NYSE: CPN) ranks 25th among Fortune's 100 fastest-growing companies, with a market capitalization just shy of $17 billion. Calpine's 36,000 megawatts (MW) of generating capacity are enough to power 36 million average households. But the 71-year-old chairman doesn't intend to stop there. After all, U.S. electricity demand is increasing 3% to 5% every year. "Every year we make a new five-year plan," Cartwright says. "Two years ago we set a target of owning net interests in 15,000 megawatts in five years' time. One year ago our target was 25,000 MW. At the end of last year, our goal became 70,000 MW. That equates to 60,000 MW of low-cost baseload facilities and 10,000 MW of peaking capacity-and we are very confident we will exceed this target. At year-end 2001, we'll set an even higher goal for 2006." The company's impressive growth derives from a carefully scripted plan of acquisitions and construction geared toward meeting a precise balance between supply and demand. "Our goal is to be the largest and most profitable power generator in North America," Cartwright declares. "The market is increasingly competitive, and we aim to be the lowest-cost producer that commands the highest prices. To do this, we need to thoroughly understand the market. This is a long-cycle business and power prices are volatile. We are not in the market as opportunistic traders." Calpine began its meteoric rise by building power plants, embracing the latest technologies in both geothermal steam and natural gas turbines, two fuel sources considered to be some of the cheapest and cleanest amongst today's practical power generating solutions. The company now boasts power plants in 29 states and Canada, with 31 of them gas-fired and 19 fueled by geothermal steam. It has 27 plants under construction and has announced another 28 in various stages of development. "This is the largest construction program in the U.S. power sector," says Charlie Chambers, Calpine vice president of business development. Although Calpine is the nation's largest geothermal energy producer, natural gas fuels the lion's share of its generation capacity, so the company has ordered huge numbers of combined-cycle gas turbines for its facilities. Among its 19 acquisitions last year is Power Systems Manufacturing, a gas-turbine component fabricator. "With 300 turbines in total, replacement parts are a big issue," says executive vice president Ann Curtis. "By purchasing Power Systems, we can keep our down time and operating costs to a minimum." By the end of 2005, Calpine expects to burn 8 billion cubic feet (Bcf) of natural gas per day, which equates to about 10% of the entire expected deliverability of natural gas in the U.S. Can the company access enough gas? "We are confident that we'll be able to meet our requirements," Chambers says. "Higher prices are allowing us to look at areas like coalbed methane in the Rockies, liquefied natural gas (LNG), North Slope and Sable Island supplies-situations that in the past were considered uneconomic. Our objective is to be right where we want to be with gas supplies, but we've obviously got a big order to fill." "Calpine is not alone among power developers in fueling its growth plans through gas-fired capacity," says Simmons & Co. International electricity analyst Kenny Kramer in Houston. "More than 90% of currently announced capacity additions are expected to be gas-fired. "With the recent increase in gas prices, there has been a lot of speculation and renewed interest in other fuel sources, mainly coal and nuclear. The important thing to remember is that while there may be a market for this, the lead time on bringing any new coal-fired and nuclear capacity online is at least four or five years. This means gas-fired generation is going to play a significant role in meeting additional demand for power during the next few years. In supply-constrained markets, this will ultimately be reflected in the price of gas and power." Calpine has a corporate mandate to own at least 25% of its natural gas requirements. "This is a key factor in being a low-cost producer," Curtis says. The balance will come from long- and short-term contracts with other suppliers. The company now owns about 1.7 trillion cubic feet (Tcf) equivalent of proved and probable reserves and is currently producing about 390 million cubic feet (MMcf) equivalent per day to fuel existing plants. In October 1999, the company owned about 150 Bcf of proved reserves. With its purchase of Calgary-based gas producer Encal in April, its total proved equivalent gas reserves increased to total 1.2 Tcf. Chambers says, "We are looking at numerous opportunities to maintain this 25% equity reserve base to support these plants. We've got to buy more reserves, develop our own properties and participate in drilling ventures with industry partners." Despite its hunger for more gas, the company keeps a low profile on its exploration ventures even within its own producing areas. "The wells we drill are low-risk exploratory wells, usually on undeveloped acreage within properties we own, and we operate about 80% of our properties," says Chambers. "We are actually a fairly large upstream company with our primary focus on acquisitions, not exploration." Cartwright reiterates that while the company has no plans to become an exploration and production company, it looks at each opportunity. With such a large gas need, supply costs could quickly spiral out of control without careful forward planning. "We are a purchaser and a consumer of gas reserves, and obviously in this higher-price gas environment we've got to pay more. We take the majority of gas through our plants as term gas. What is important for us is to lock in gas contracts and ownership in gas to match with our power contracts. This is our spark spread, the margin between fuel costs and at what price we sell electricity, which provides us opportunities to lock in some advantages." Last year the company's spark spread averaged about $30. This year it is closer to $22. Cartwright explains, "This is why forward planning is so important to both our equity gas situation and our term gas. If we own it, we know what it costs so we never get exposed on the spark spread. This is a very important operating principle. We never leave ourselves open to that risk." Chambers adds, "Roughly 60% of our cost of doing business is fuel cost. The cheaper we can put gas in our plants, the cheaper we can produce electricity, so it is really important for us to have a diversified portfolio of fuel around the country that is served by the major pipeline systems." Midstream assets Calpine is becoming more of a midstream player as well. It just announced a large pipeline development project with Kinder Morgan and purchased pipeline capacity in other areas. "We have capacity on other systems around the country where we move our equity gas to our plants," says Chambers. "We are integrated from top to bottom, upstream to downstream." The company is in the market to contract for pipeline capacity and is looking to take equity positions in pipelines as well as expand storage capabilities. It is looking at 100 different project-generation pipeline opportunities. Financing such aggressive expansion has been a challenge, but one that Calpine has so far been able to meet. It has a $3.5-billion revolving line of credit to finance its construction program and has raised $6.4 billion in the past 12 months in successful capital markets transactions. "This type of growth takes a lot of capital," Curtis says, "but we are confident we will be able to continue to raise the funds needed. We're very close to becoming investment-grade." Fitch-one of the three major credit-rating agencies-already rates the company "investment grade." It says Calpine consistently meets its financial and operating goals, its generating assets are competitive, it has a highly experienced management, and it has a flexible financial structure to take advantage of debt and equity opportunities. With a capital structure targeted at around 65% debt and 35% equity, ample short-term liquidity, and adequate fixed charge coverage, Calpine's overall financial profile is deemed by Fitch to be reasonable and should improve as new generating plants become operable and generate higher levels of cash flow. Kramer, of Simmons & Co., says, "In today's market, building out a portfolio of 70,000 MW requires anywhere from $30- to $50 billion in total capital. Calpine has already raised a significant amount of capital and has proven itself to be very adept, but obviously the company will continue to need to tap the equity and debt markets on a regular basis in order to fulfill its growth strategy." During the past few years, Calpine has had a great earnings track record and been a darling of the capital and project finance markets, he adds. "If the company is able to continue to successfully bring plants online and grow earnings while investors continue to be enamored with the 'power' story, the company should have adequate access to capital in order to sustain its momentum." That momentum includes revenues that rose 171% last year to $2.3 billion, and the company recently increased its 2001 earnings expectations. Its common shares were around $53 at press time, nearly double their worth a year earlier. At a recent annual meeting, shareholders voted to increase share authorization to 1 billion, from 500 millions. "We have outperformed the S&P 500 and the Dow," Curtis says. "Many people have said to me they wish they had bought our stock when it was about $2, but I tell them now is also a good time to invest. I think we've still got tremendous growth potential." Deutsche Banc Alex. Brown initiated coverage in November 2000 with a Strong Buy and a 12-month target of $115 per share. The research firm expects Calpine annual earnings growth of approximately 40%," "The primary risks are excess generating capacity and gas prices. The current shortage of capacity and Calpine's technological advantage over incumbents significantly reduce our concern about the risk of excess capacity during the next two to three years," a DBAB report says. For these and other reasons, the only way rising prices could hurt its results in the near to intermediate term is if electricity prices declined while gas prices rose, and the firm does not expect a material inverse divergence in the price of gas and electricity in the next two years. Merrill Lynch analyst Elizabeth Parrella says, "Calpine is our top pick...with a 12-month price objective of $78, up 54%. The company is on track to deliver 30% to 35% annual earnings-per-share growth during the next five years." Meanwhile, Cartwright says Calpine's strategy will be to concentrate on North America for the next five years while keeping a watchful eye on international expansion down the road. "There are very large markets out side the U.S. In Canada, we have several projects in the negotiation and acquisition stage. In Mexico, we see a very attractive market and are looking at opportunities to send our power south of the border. This will require building transmission lines, and we may be able to participate in building power plants there as well. We are evaluating Europe, especially the U.K., Spain and Italy. They have the same characteristics as what made the U.S. market so attractive after deregulation. "At the end of our next five-year period, when things may start tapering off in the U.S., we can continue our growth in international markets." Employee compensation represents the largest portion of Calpine's operations and maintenance budget. To achieve its business model, it needs to hire three employees per day, making the procurement of intellectual capital a significant challenge during the next several years, especially given today's tight labor market, says the Credit Lyonnais Securities (USA) research team, which has a price target of $63.50 on Calpine common shares. "As we add megawatts, we can add people to accomplish our goals," Curtis says. "All of our employees are shareholders, so they take a personal interest in our growth. By the time we attain our 70,000-MW goal, we'll have 6,200 people on staff. And with a less than 2% turnover rate, we've got unprecedented loyalty." Chambers adds, "We are fairly new on everyone's radar screen, particularly as a significant natural gas producer. People classify us as a utility, which we aren't. We are much more than that. We are an integrated power producer with nothing but growth in our foreseeable future." LOCKING IN GAS SUPPLY When Calpine purchased Calgary-based midsize producer Encal Energy in April for $1.2 billion in stock (including US$225 million of assumed debt), it pulled off the biggest coup in its corporate history. "The purchase was a logical outcome of Calpine's strategic objective to have 25% of its gas requirements be equity gas," says Calgary-based Scotia Capital managing director Mark Herman. "The company has been looking very carefully on both sides of the border for gas producers." Now that the deal is complete, Calpine is looking at a number of other opportunities to expand in the Canadian marketplace. "I can't comment on what it is looking at now," Herman says, "but I would guess it is looking at anybody and everybody. Of course, there is a huge difference between looking and buying. Calpine's 25% equity gas target works out to about 2 billion cubic feet a day by 2005. That's a lot of gas." Early discussions between Calpine and Encal were "very much philosophical in nature for both sides," he adds. "Calpine was looking for a management team that would lead its gas efforts on this side of the border. Despite the difference in size of the companies, it was very much a partnership. They very much wanted not only the management, but the technical team-the geologists, engineers, and so on." Once Calpine completed extensive due diligence, the real negotiating began and at that point, Scotia Capital entered the picture, already one of the company's major lenders. Calpine is one of the first in its sector to take advantage of the promise of Canada's rich natural gas supplies. The company will use the new reserves to fuel a number of its new power plants that will come online in California and elsewhere in the U.S. in the next two years. Although Encal is probably best known as the largest oil producer in British Columbia, more than half of its production is natural gas, making the purchase a strategic fit for Calpine. Some speculate Calpine will sell off or swap Encal's petroleum assets for more gas production later. "Calpine has very good access to capital markets," Herman says. "I'm sure they have the resources to make future acquisitions." Houston-based Scotia Capital managing director Mark A. Ammerman says, "The market is really trying to adjust to having buyers like Calpine out there because they are shrewd buyers and they have a business model that allows them to value a gas purchase differently than a competing independent producer would."