Calpine Imploding

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News flash: You can't rewrite the terms of existing debt indentures in order to remain solvent.

Calpine(CPN Quote), which I have been vehemently bearish on since early August, learned that lesson the hard way Tuesday, when a Delaware court judge ordered the nearly illiquid power producer to repay $313 million to a trustee account.

The company had created the trustee account to hold the $709 million left over after it tendered for first lien debt from the sale of its natural gas assets back in July. Also, under this ruling, Calpine is now forbidden from spending the remaining $400 million in the account to buy contracted natural gas to fire its plants.

For those dreaming of an appeal, I would point you to this excerpt from Judge Leo Strine's decision:

In this opinion, I conclude that Calpine's proffered interpretation of the relevant exclusion from the term Designated Assets is erroneous. By any measure, Calpine is using Rosetta Proceeds to buy "natural gas supplied under ... [a] contract for the sale or purchase of natural gas..."

There is no ambiguity in this ruling.

Ironically, Calpine, which needs natural gas to fire its plants and make a profit on its power sales, has been on the wrong end of one of the worst natural gas trades in history. It sold its natural gas assets in July when natural gas prices were in the $7's.

Calpine now has to go out and buy natural gas assets with prices in the $11 range. This type of commodity miscalculation can have a devastating impact on the liquidity of any company, and Calpine's weak financial footing only exacerbated the case here.

This ruling has dramatic implications for Calpine.

I believed that Calpine was waiting for a positive ruling in this case before it would sell off its California generating assets for more than $2 billion.

The ruling, however, would seem to make such a sale fruitless, because the company will be severely restricted on how it can use the proceeds. Under the terms of the indenture, it will have to use the money to either buy long-lived assets in an effort to resecure bondholders, or it will have to buy back bonds at par. With all of Calpine's debt trading at 20% or more of a discount to par, it is uneconomical to buy back bonds, and buying natural gas reserves to burn in its plants in the next year does very little for liquidity.