What’s wrong with North America’s market for wholesale electricity? Over the past 12 months, we’ve witnessed the bankruptcy of major independent power producer Dynegy (NYSE: DYN), despite the backing of billionaire investor Carl Icahn.

Major utility Exelon Corp (NYSE: EXC) cut its dividend for the first time since the merger of Philadelphia Electric and Commonwealth Edison. Smaller Independent power producer Atlantic Power Corp (TSX: ATP, NYSE: AT)–a company that managed to raise its dividend in November 2008 at the height of the financial crisis–recently slashed its dividend by nearly two-thirds. And virtually every other company producing and selling power wholesale has seen margins squeezed in the fourth-quarter and full-year 2012.

Dominion Resources (NYSE: D) has consistently been among the healthiest producers in US wholesale markets in recent years, thanks to well-run assets and aggressive hedging. This week, however, the company took a huge step out of the business by selling two large coal-fired power plants in Illinois and another in Massachusetts to a private capital firm.

The company still has some wholesale assets, including the Millstone nuclear power plant in Connecticut. But management has made no bones about the fact that it will invest the $600 million or so in cash proceeds from the sale in its regulated power assets in Virginia and energy midstream assets in the Middle Atlantic, or otherwise cut debt. And after this sale, regulated and long-term contract based businesses will be the source of virtually all of its future profits.

Dominion’s exit is a clear sign that the power industry’s deepest-pocketed players don’t see much near-term upside in selling electricity at unregulated prices to regulated distribution utilities and other large users. And its move parallels similar actions by other large companies in recent years to “de-risk” themselves from what’s become a troubled market with few signs of recovery any time soon.

In fact, about the only wholesale producers that are still growing assets and profits are companies focused on renewable energy. Unlike conventional nuclear, coal or even natural gas-fired plants selling into wholesale markets, renewable energy use is mandated in some 38 states plus the District of Columbia. Utilities operating there must buy or produce set percentages of their output from these sources, typically solar, wind or biomass projects.

Renewable energy developers have only to submit a winning bid for a wind or solar farm, and they’re guaranteed a long-term contract at a premium price once the facility is in operation. Profits are consequently not affected by swings in wholesale power prices. In fact, as long as companies execute projects, future earnings visibility is extraordinarily good.

Renewables’ position in the market is mandated by laws that appear to be set for another four years. As a result, wind and solar don’t have to compete with the cheap natural gas being produced from the prolific shale plays. And because the law locks in contract prices, they don’t have to worry about low wholesale electricity prices undercutting margins either.

Revenue from renewable energy under long-term contracts is a major plus for Sempra Energy (NYSE: SRE) and other big utilities that have invested in projects that they’ve later contracted to regulated companies. And for other companies, it has substantially offset lost margins in sales from coal and nuclear power into wholesale markets.

Wholesale Blues

The US wholesale power market basically came into being during the late 1990s, when 18 states plus the District of Columbia decided to functionally separate the business of generating electricity from distribution and transmission. In those states, transmission and distribution remained regulated, while generation was thrown open to competition, with prices set by the highest bidder.

At the time, gas-fired plants were the primary form of new generation, and so the cost of natural gas began to figure prominently in the price of power as well. That’s held ever since, though the price of gas has varied widely, from less than $1 per million British thermal units to the upper teens in the wake of Hurricane Katrina.

With the advent of US shale production, the domestic supply of natural gas is in such abundance that when adjusted for inflation it’s practically as cheap as it was back in 1999. As a result, gas-fired power is far cheaper than anything else on the wholesale market, with the exception of especially efficient hydro facilities. Even nuclear plants–with their extremely stable fuel costs–can’t always compete, as plans to shut down a small plant in Wisconsin and a larger but problem-plagued facility in Florida demonstrate.

The result is wholesale power is cheap, and margins are getting squeezed. And while these conditions last, only companies with scale, reach and strong balance sheets can afford to play.

In some ways, the current situation for independent power is similar to what happened following the 2001 collapse of Enron. Then, prices crashed and leveraged entities were wiped out.

The big difference this time is the list of the vulnerable is considerably shorter. A decade ago, even Dominion Resources suffered a big blow to earnings and its share price. This time around, despite sizable writeoffs for the divestment of power plants, management is still projecting outsized dividend growth at an annualized rate in the upper-single digits for the next several years. And its home state of Virginia has rescinded deregulation, so its power utility continues to enjoy a monopoly.

Meanwhile, some states such as Texas actually face potential power shortages. That’s a unique situation now related to the consequence of underinvestment and the state’s geographic isolation from the rest of America’s power grid. But sooner or later, what’s happening in Texas will happen elsewhere, due to plant shutdowns (including coal in the Northeast) and a move to more global pricing for gas once it can be exported overseas.

Those investing in the wholesale power business now face challenges and will for some time to come. Companies most reliant on the spot market–particularly in the Northeast–will have to ensure they’re adequately hedged, or at least sufficiently deleveraged.

If they can survive this tough period, they’ll be in great shape when the cycle turns. And if history is any guide, that will happen when it’s least expected. Those who buy their stocks, however, need to be patient, as well as willing to constantly look at revenue to discern what might be vulnerable.

North American wholesale power isn’t dead. But companies in this business will have to overcome significant challenges to be worthy investments.