The New Energy Landscape, Part 2

 | Mar 04, 2013 | 6:00 PM EST  | Comments
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Stock quotes in this article:

nrg

,

exc

,

cpn

To see Part 1 of this article, please click here.

After the successful merger of several large utilities last year, a new energy landscape formed. Today, the nation has three major independent power producers: NRG Energy (NRG), Exelon (EXC) and Calpine (CPN) with very different strategies.

Part 1 of this series described how each company has different fuel strategies. Calpine's capacity is dependent on natural gas, most of NRG's capacity is tied to a blend of natural gas, coal and oil, and most of Exelon's capacity is nuclear (while the outcome is largely unchanged, I caused an error in the graph).

Of course, fuel strategies are critical. But geographical strategies are also critical. The wrong fuel in the right location can be profitable. But the wrong fuel in the wrong area can spell big trouble.

So geography is another critical success factor where the best locations are usually found near population centers. High population areas not only require more power, most have constrained delivery systems, which makes it difficult to import surplus power from low-cost regions. As a result, local generators supply higher priced power without competition from remote suppliers.

Why not build more transmission lines, relieve congestion, import cheap power, and lower energy prices? The answer is not as simple as some might expect.

Obviously, building a new transmission line in congested areas is nearly impossible. Nobody wants giant transmission lines in their back yards or near pristine areas. Even if they were willing, the cost for the right of ways can be prohibitive.

Not so obvious is history. Not long ago, some transmission assets were constructed tactically. The idea was to protect native utilities and their ratepayers from neighboring states.

One example was Connecticut. Utilities wanted to build a cable from Connecticut to energy-starved Long Island. Fearing an energy drain would elevate local prices, Connecticut officials obstructed the 330-megawatt line until the federal government finally stepped in, declared an emergency and fought their decision in federal courts.

It wasn't just competition from out-of-state utilities. It was also competition from out-of-state regulators. Texas built their Electric Reliability Council of Texas (ERCOT) to make sure none of their electricity would be regulated by the federal government. They accomplished this by electrically isolating ERCOT from power produced in other states.

For different reasons, California implemented similar strategies. They created a "virtual fence" making trading power in and out of California difficult and costly.

For investors, it should be clear there is no such thing as a national grid. Instead, we have a loosely knit collection of regional grids. Even if power could be moved from one region to another, often the costs of long distance movements become prohibitive.

With this in mind, investors should look carefully at NRG, Exelon and Calpine's location strategies. As can be seen in the accompanying graph, each company has different strategies.

 

Generating Capacity

 

Most of Calpine's assets are located in Texas, California and the Mid-Atlantic (Pennsylvania, Delaware and Maryland.) Approximately 50% of their capacity is located in two states – Texas and California. Calpine represents several simultaneous gambles. They are gambling in natural gas. They are also gambling in policy outcomes currently considered by Texas and California.

In many ways, NRG looks like Calpine. Almost 42% of their generating assets are also located in Texas and California. But NRG is not a pure play in natural gas. NRG owns coal, nuclear, natural gas and renewable energy assets in their Texas market. In their California market, NRG owns mostly natural gas and a little solar.

Nevertheless, Texas and California power markets are currently capacity short. Neither state has enough power to meet projected peak loads. Both states expect more plants will exit their markets, exacerbating shortages.

Texas and California must adjust their energy policies to address capacity shortages. Those adjustments will affect Calpine and NRG's earnings. More transmission lines, more renewable energy sources and new energy efficiency programs could threaten earnings.  Adding and adjusting capacity payments could improve earnings. In either case, state regulators represent risk for Calpine and NRG.

Then we have Exelon. Exelon's generating assets are located mostly in the Midwest and in low population areas. Their lower-cost energy cannot always reach higher-priced markets. Investors gambling on Exelon are not only gambling on nuclear power, they are also gambling on the Midwest. Specifically, they are gambling on an economic renaissance in the Midwest.

Each company has a different fuel strategy. Overlapping their fuel strategy is their geographic position. It would be physically difficult, incredibly costly and time consuming to change these strategies. They can only make changes around the margins. Good or bad, these companies are locked in. 

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