Electric Power Industry and Stocks

One of the most intelligent guys in the power industry is named Wayne Leonard. I was told that he started in the plant accounting department at Public Service of Indiana (not usually the starting point for CEO’s) and then PSI merged with Cincinnati Gas and Electric to form Cinergy which was then bought by Duke power. Wayne left when they were still Cinergy and went to Entergy, which is a big southern utility based out of shattered New Orleans. I remember seeing presentations by business unit when I was at Cinergy and Wayne’s stuff was over my head while the other divisions were essentially mouth-breathers. I would always recommend watching Mr. Leonard’s actions to see where the industry is heading.

In parallel, readers of this blog have seen my heckling of Exelon for pretending that their local distribution company was a separate entity from their massively profitable power generation entity, such as this post. Readers have also seen my post recommending that the State of Illinois seize the nuclear power plants from Exelon here at this post (I realize that this is odd coming from a libertarian, but there is a method to this madness) – if you are interested just go to LITGM and type “Exelon” in the search box to see more.

The underlying issue is that power companies should be viewed as two main entities 1) distribution companies that purchase power from someone else and serve cities 2) generating companies that make power and sell this power to distribution companies. The value of #2 electricity companies is ALMOST INFINITE – meaning that since no one is creating new base load plants while demand increases, you can sell power for the highest price the market will bear indefinitely. The only blips on the horizon are the fact that at some point you bleed the distribution companies so badly that they go bankrupt and the states start to look around for more desperate solutions (like seizing the assets, the assets that rate payers paid for originally). The value for #1, however, is negligible – they usually make a return on capital and this return is being hacked away by local politicians and governments because more money is going to the generating companies and they don’t want to raise rates. Usually they received about a 10% return on equity and this is going down into the single digits, around 8%. And this 8% isn’t without risk, either.

The investment issue is that many companies are a mix of #1, highly valuable plants, and #2, virtually worthless distribution companies. As integrated entities, you can’t get the value for #1 because the governing authorities make you give a lot of it back by not letting #2 go bankrupt.

What to do? Watch Mr. Leonard. He is proposing spinning off the super-valuable nuclear plants from Entergy to form a separate company (which raised the stock price about 5%). Current share holders will receive shares of this new entity (called Spin-co for now) and this will be their reward, since these shares are expected to be richly valued by the market (and this value will fall to current share holders).

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I spent over a decade working in the energy industry, focusing on electric and gas utilities. These utilities have some key similarities and some differences – they both have transmission (pipelines and overhead transmission lines) and distribution (local lines into your home), as well as customer service (local trucks, service, and billing). Gas companies don’t have “generation” in terms of power plants, but they do have drilling and gathering (within the US) or entry through a liquefied natural gas (LNG) port from a third countries, then into a pipeline.

Gas can be stored under pressure; in the summer gas companies historically injected gas under pressure into the ground, which they then pulled out of storage in the winter when gas demand “peaks”. In the summer, gas prices are at their lowest (maybe $2-$4 / unit) and then they are at their highest in the winter ($8 – $10 / unit). In the olden days (when I worked in the early 90’s) gas wasn’t “marked to market” every day; the gas company was either short or long gas on a given day, and then they trued-up with their suppliers periodically. In my audit I pointed out that the local utility had been “shorted” gas by their suppliers in the winter (when prices were high) and their suppliers made it up in the summer (when prices were low) – by this I pointed out that the local utility was losing hundreds of thousands / year by trading the same commodity in this unfavorable manner (even though the # of units were the same).

Electricity isn’t as widely traded as a commodity because it can’t be stored (at least not effectively). Thus its price can range from negative (it can be more expensive to restart a giant plant than to run it and sell the electricity at a loss) to almost an infinite price if it is a hot day and the transmission lines are overloaded so that only local generation can satisfy the demand. The price would need to be determined by location (city) and then by time; thus electricity can be cheap in one location or overnight and then by sky-high at a neighboring city during 1pm during the heat of the day.

Another element that electricity and gas have in common are “classes of service” – they include residents, government (street lighting), small businesses, and large businesses. Each of these utilities have chronic and continuing arguments to determine how to spread the burden ACROSS these classes of customers; government usually pays the least, but then it goes backwards from large businesses to small businesses and then residents, on a per/unit basis. There are convincing arguments for each class; the big business customers put almost no demand on distribution and customer service but put a huge burden on generation (unless they have their own generation); while individual customers go the other way. The “joke” in the industry was that you could raise rates as long as you didn’t raise them for their rate class (I never said utility people were particular funny).

The point of this isn’t really gas or electricity; it is water. Water is relatively similar to a gas utility with a transmission and distribution network. Water doesn’t have generation but is gathered through wells or collection (dams).

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Power… and the naive

Two frequent topics intersect in this Wall Street Journal article from today, October 29th titled “Power Firms Grapple with Tough Decisions”. The topics are 1) journalists that don’t understand what they are writing about 2) the impossibility of improving our US infrastructure in today’s legal and regulatory climate.

The journalist writes that “A year ago, it looked as if 100 coal-fired plants might get built.”

Only an incredibly naive person who didn’t understand anything about the history of the US energy industry would have assumed for an instant that ONE HUNDRED coal-fired plants could possibly be built in the US. Let’s sum up the power situation for you:

1) NUCLEAR – great, unless you worry about storing the radioactive waste
2) HYDRO – great, unless you love fish and babbling brooks
3) COAL – great, unless you worry about global warming
4) NATURAL GAS – great, unless you are paying the bill
5) SOLAR – great, unless you need power on peak and the sun isn’t shining
6) WIND – great, unless you don’t like the way they look, slice birds, and the fact that they are unreliable on peak

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Nuclear Power and The Chicago Tribune

On the editorial page of the Chicago Tribune they recently wrote an article titled “Restored Faith In Nuclear Power”. This article summarizes the recent earthquake in Japan and the fact that it occurred right under a nuclear plant. Even though the plant wasn’t rated to support an earthquake, it withstood a 6.8 magnitude earthquake with only minor damage and no radiation leakage.

Next, the article talks about the fact that there is some nuclear construction occurring in the US. They cite the Tennessee Valley Authority (TVA) and the fact that they restarted the Browns Ferry Nuclear Plant in mid-May 2007 after a $1.8 billion effort, which took 5 years. Other nuclear plants on the drawing board are supposedly reducing the licensing frame to four years and construction to three years, meaning that nuclear plants could come online in seven years.

The article also mentions that the UN report on global warming mentioned that nuclear power had to be part of the mix alongside wind and renewable resources to reduce global warming. Thus, they conclude, the US can have faith in nuclear power, and left the feeling that in fact more nuclear power is on the way.

While I personally believe that nuclear power IS an essential part of our energy portfolio and that encouraging nuclear power is good for the country and our balance of trade, I think that this editorial is way too optimistic and there in fact is little hope of a nuclear power revival in the US.

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