The bond market has never been more pessimistic on the chances of KKR & Co. and TPG Capital being able to salvage the biggest leveraged buyout in history — the $43.2 billion purchase in 2007 of the electricity provider known then as TXU Corp.

Since the private equity firms bought the Dallas-based company, now known as Energy Future Holdings Corp., with $45 billion in debt financing, natural gas prices have tumbled 50 percent as a process for extracting the fuel from shale called fracking rises in popularity. That has cut electricity prices in half as well.

Less than a year after extending the maturities on more than $17.8 billion of debt, credit-default swaps traders are pricing in a 91 percent chance that the company will fail to meet its obligations in the next three years. Its debt securities yield about 21 percent on average, up from 15 percent when the refinancing was announced in April.

“The clock has gotten much louder for TXU with this recent falloff in natural gas,” said Jon Sablowsky, the head of trading at investment firm Brownstone Investment Group LLC in New York. The company is overlevered and doesn't have “enough revenue to service that debt going forward, nor enough revenue to provide the confidence to investors to help them refinance that debt,” he said in a telephone interview.

KKR and TPG are losing a bet they made in 2007 that natural gas prices would continue to drive wholesale power prices higher, a wager that soured when a recession sapped demand just as drilling expanded in the gas-rich Marcellus shale in the eastern U.S.

Wholesale electricity prices plunged as gas prices dropped, hammering independent wholesale generators such as Energy Future that don't have the protections given to regulated utilities where states allow a certain level of profits.

The concern among credit traders has grown more urgent as the plunge in natural gas prices raises the potential cost of renewing hedges against price swings that expire in 2015.

Three-year credit-default swaps tied to Texas Competitive Electric Holdings, the company's unregulated merchant power unit known as TCEH, have soared 45.7 percentage points during the past seven months to 69.5 percent upfront yesterday, according to data provider CMA. That's 4.4 percentage points less than the cost for five years of protection, compared with 24 percentage points on June 15.

The price means the initial cost to protect against a default on $10 million of the company's debt through March 2015 has climbed to $6.95 million from $2.38 million in June.

Recovery Rate

The contracts are trading at levels that imply a 91 percent chance of default, based on market assumptions that bondholders would recover 14.5 cents on the dollar in such a scenario, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

Kristi Huller, a spokeswoman for KKR in New York, whose co-chairmen are Henry Kravis and George Roberts, and Owen Blicksilver, a spokesman for Fort Worth, Texas-based TPG, declined to comment.

Energy Future “generates stable cash flow through solid operational performance in a growing market, has adequate liquidity and has re-worked its capital structure to reduce debt and extend debt maturities,” Allan Koenig, a spokesman for the company, said in an e-mailed statement. The power producer employs more than 9,000 people, up 25 percent from 2007, he said.

Gas supply in the U.S. has grown since producers learned to use hydraulic fracturing and horizontal drilling to tap deposits locked in dense shale rock formations.

The commodity, which traded as high as $13.58 in July 2008, will stay below 2011's average price of $4.026 for the next two years, or about $3.10 per million British thermal units for 2012 and $4 for 2013, according to Robert W. Baird & Co., an investment bank in Milwaukee. Natural gas for February delivery fell 12.6 cents, or 5.1 percent, to $2.346 per million British thermal units today on the New York Mercantile Exchange, the lowest settlement price since March 2002.

That price is “brutal” for Energy Future because TCEH needs $6.15 to break even, and leaves “zero recovery” for bondholders beyond the first lien, said Andy DeVries, an analyst at CreditSights Inc. in New York.

Price Hedges

Hedges that contributed to one-time gains of $89 million last quarter by locking in natural gas prices expire by 2015, according to the company's most recent quarterly filing with the U.S. Securities and Exchanges Commission. The hedges lock in natural gas at a weighted average price of about $7.36 for 2012, compared with a weighted average market price of $4.24.

“They're so well hedged in the near term, and they've got some room under the maintenance covenants so weak gas prices shouldn't be a problem this year,” DeVries said. “It's when the hedges start to expire when push comes to shove.”

Energy Future reported a loss of $710 million on Oct. 28 for the third quarter, as interest expenses and related costs rose by 50 percent and sales fell 11 percent. The company and its wholly owned power-delivery unit Oncor Holdings had long- term debt of $40.18 billion. U.S. Environmental Protection Agency rules intended to reduce cross-state air pollution will cost the company $1.5 billion through 2020, the company said in a lawsuit with the U.S. Court of Appeals in September.

Lenders agreed in April to extend debt maturities on about $17.8 billion of the company's debt and swapped some holdings at discounted prices for new securities.

“We view Energy Future Holdings Corp.'s multiple distressed exchanges and credit facility extensions as tantamount to default,” Standard & Poor's analysts Aneesh Prabhu and Andrew Giudici wrote in a Jan. 11 note.

Texas Competitive's $1.87 billion of 10.25 percent bonds due November 2015 dropped 7 cents to 28 cents on the dollar this year, yielding 60.564 percent as of Jan. 17, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.

“Even if you're secured, you have to be scratching your head and wondering where the mechanism for repayment is coming from,” Bonnie Baha, the head of the global developed credit group at DoubleLine Capital LP, which oversees $23 billion, said in a telephone interview from Los Angeles. “Given the competitive landscape, given the changes that have occurred in the natural gas industry that weren't really foreseen at the time these deals were structured, I'd say your capital is better deployed elsewhere.”

Prospects 'Negative'

Energy Future's term loan maturing in October 2017 traded at about 61.3 cents on the dollar yesterday, from 63.6 cents on Jan. 9, according to Markit Group Ltd. The term debt due in October 2014 was trading at 64.7 cents from 69 cents.

Energy Future unit Oncor Electric Delivery has $375.6 million of 6.375 percent notes maturing in May and $524.7 million due September 2013, according to data compiled by Bloomberg. About $3.8 billion of TCEH loans mature in October 2014, Bloomberg data show.

“There are no near-term maturities and there's no maintenance covenant that can be tripped in the near term, but there's a view that they're not going to be able to refinance their debt at TCEH,” Chris Chaice, an analyst at New York-based Covenant Review, said in a telephone interview. “Long-term prospects are very negative for TCEH. The time at which they can no longer support the capital structure is growing nearer.”

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Market Skeptical About TXU Deal

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