Good Times in the Energy Sector

 | Mar 31, 2014 | 5:00 PM EDT  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

exc

,

nrg

,

aep

,

fe

,

peg

,

cpn

The first quarter is in the books and it should be a great one for power producers. In particular, Exelon (EXC) and NRG Energy (NRG) should record strong revenues and strong gross margins. Integrated companies like American Electric Power (AEP), First Energy (FE) and Public Service Enterprise Group (PEG) should see improved results for their unregulated subsidiaries.

Cold weather and natural gas prices were primary drivers. The polar vortex that blasted artic air over much of the eastern U.S. strained the nation's infrastructure. In many regions, natural gas pipelines saw nominations well beyond pipeline capacity. Consequently, natural gas could not reach local distribution companies or generating utilities.

The combination of cold weather and constrained pipelines pounded the power sector. With marginal generators sidelined due to natural gas limitations, grid managers found their reserve margins obliterated.

As I described in "Where Were You When the Nation's Power Ran Out?", the Eastern Interconnection and Texas ran out of power plants in the first quarter. With demand exceeding supplies, grid managers were forced to activate reserve generators, which typically have very high production costs. In some cases, even those generators were not enough and managers initiated rolling brownouts.

Seemingly, Bad News Is Good News

Companies operating power plants that relied on low-cost and stable fuel celebrated when natural gas prices soared. They had good reason: Natural gas sets power prices for most of the nation's coal, nuclear, hydroelectric and renewable energy production.

According to Natural Gas Intelligence, natural gas prices exploded in the first quarter. For generating utilities, delivered prices were much higher. The reason is basis. While some traders focus on the Henry Hub nat-gas distribution system, the action for power producers is not Henry Hub. The price that matters is the price at delivery points, or citygates.

Price differences between Henry Hub and citygates were huge. In several cases, citygate prices blew past Henry Hub's price by a factor of 10. Because of pipeline constraints, delivered prices on the other end of the pipe were extreme. That made market-clearing prices for wholesale power equally extreme.

A few real numbers might be helpful. If a gas turbine buys their fuel at $50 per million British thermal units (MMBtu), that turbine will produce power for approximately $400 per megawatt-hour. If the grid needs that turbine to meet demand, the minimum price all generators earn should be $400 per megawatt-hour. If the grid needs higher priced generators, the market-clearing price will exceed $400.

To some, these numbers sound terrible. To others, these numbers are a dream come true. Let me explain.

While delivered natural gas prices were soaring past $10, $20 and in some cases $100 per MMBtu, coal prices remained low and steady. For the quarter, the Energy Information Administration (EIA) reports prices for coal from Powder River has been below $0.75 per MMBtu. Uinta Basin has been below $1.55 per MMBtu. Illinois Basin has been below $2. Northern and Central Appalachia have been below $2.70 per MMBtu.

During the quarter, the price differences between delivered natural gas and delivered coal has been huge. For the first time in months, base-loaded coal plants should see healthy gross margins. Even marginal coal plants should earn strong revenues.

If coal is strong, nuclear is better. A rule of thumb is $45. If the average market price of power exceeds $45 per megawatt-hour, most nuclear power plants should be profitable.

In the last quarter, when the Eastern Interconnection and Texas ran out of power plants, the market price of power exceeded $200 per megawatt-hour. During those hours, the profit available to coal and nuclear was well over $100 per megawatt-hour. In fact, there were times when the profit was over $1,000.

But be careful: It is not necessarily good news for everyone. Companies like Calpine (CPN) should see similar revenue, but gross margins may be tighter. Because its fuel is natural gas, Calpine's margins are calculated differently. They are based on spark spreads, which are the differences between its delivered costs of natural gas and local market-clearing prices for wholesale power. Unlike its colleagues, Calpine does not benefit as much when natural gas prices spike.

While the first quarter should be strong for other power producers, the second quarter will be weak. Starting tomorrow, power markets enter the shoulder period when demand normally decreases. It is seasonal. It is expected. It is the lull before the summer.

If a cool summer is in store for 2014, power and natural gas prices will decline. For coal, nuclear and renewable energy, falling power prices mean tighter margins and earnings. However, if this summer is as hot as last winter was cold, good times will be back for leading power producers.

Columnist Conversations

VIX did not care one wit for the decent jobs report. Stocks are trading on Ebola, HK, ISIS, Russia and other ...
My baseline view of the December Es contract, and the market as a whole remains unchanged. I continue to belie...
I mentioned the eveningstar pattern on the daily chart of the DJIA
Stocks to watch this morning include…Nice breakfast…General Mills is laying off 800 salaried wor...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.