Something in me doubts he could win the nomination... best case scenario is he replaces John McCain as the more moderate second runner up to Bush.
I agree with this. HOWEVER, here's another take on events:
Colin Powell runs for the Republican nomination in 2000. He is entangled with Governor Bush in a very difficult primary battle, in which Bush overwhelmingly wins Iowa, but is then routed by a solid Powell win in New Hampshire, and then wins a landslide victory in South Carolina, and at the end of the primaries, Powell withdraws and endorses Bush. Probably early in the primary race, Senator McCain withdraws and endorses Powell, and that's probably the last anyone will ever hear of John McCain in presidential politics.
However, Powell is aware of the tradition that the Republicans nominate for President every election the runner-up from the last election. Privately concerned with the ultra-conservative direction of President Bush, Powell probably doesn't accept the position of Secretary of State in the Bush administration (though he might, as he was very genuinely patriotic and nonpartisan) and instead opts to work privately to prepare for a 2008 presidential bid. So when 2008 comes around, Powell runs again, and with a more moderate GOP, Powell wins the nomination.
Of course, that leads to a very interesting general election. Sure, butterflies might lead to a Hillary Clinton nomination, but there's still a good chance Obama could be nominated. Two African Americans running against each other at the same time? Epicness.
From there, I can't say who wins. I'm inclined to say Powell, as long as he stays as a moderate, as he likely would; however, 2008 was a very Democratic year, so I wouldn't rule out an Obama win either. Whoever is elected however, it will be a very close election, maybe even like 2000.
I suppose this isn't the MOST plausible scenario. A few problems I can think of:
* Powell staying out of the Bush administration; Bush would still likely want Powell as SecState, and Powell was always very nonpartisan and could very well have put aside all his political ambitions and decided to serve his nation inside the administration. But I still don't think this is a 100% guarantee; after a close 2000 run, Powell might decide to try again in 2008, and he would know well in advance that joining Bush as SecState would be a bad decision.
* I suppose it isn't even a guarantee that Powell would win the nomination in 2008. True, he would try spending the eight Bush years trying to bring the GOP to the center, but he would be fighting President Bush in this. I'm not sure if Powell could be entirely successful in bringing the GOP to the center with the GOP feeling obliged to support right-wing President Bush in all his actions.