Getting in Front of the News

 | Jun 14, 2013 | 7:00 PM EDT  | Comments
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Stock quotes in this article:

exc

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nrg

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cpn

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dyn

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enoc

It is like clockwork. Around June 20 of every year, the nation's power markets suddenly light up. It is not a gradual ramp up; it is a sudden shift in demand. There seems to be a collective awakening where everyone turns on their air conditioners in unison and leaves them on. Those air conditioners place a huge load on the grid and power producers respond. With new demand in a market of fixed supplies, wholesale power prices jump.

Higher demand and higher prices are good news for producing companies like Exelon (EXC), NRG Energy (NRG), Calpine (CPN) and Dynegy (DYN). In all likelihood, they will see improved short-term outlooks as their revenue and margins improve.

Companies fueling these independent power producers should also see increased demand and stronger prices. This includes coal-producing companies like Peabody (BTU) and natural gas producing companies such as Chesapeake (CHK) and Southwestern (SWN).

Investors should carefully watch natural gas prices. Today, spot prices are relatively low. As the air conditioning season approaches, demand for natural gas should kick in and spot prices should rise. As higher natural gas prices migrate upwards, power producers using coal, nuclear, hydroelectric and renewables should see higher revenue and improved margins.

Investors experienced the same phenomenon last year. However, last year natural gas prices were much lower. In fact, they were so low that coal and nuclear plants frequently found themselves operating on the margin. When a power plant operates on the margin, their gross margin for energy is near zero.

Source: EIA/INO/Williams

However, with higher gas prices, more natural gas-fired power plants will find themselves operating on the margin. Elevated natural gas prices will help utilities relying on coal, nuclear, hydroelectric, solar and wind. In general, these utilities should all book improved gross revenue and margins.

On the other side of the table are EnerNOC (ENOC) and its competitors. As demand and prices migrate upwards, demand-response programs kick in and shave off peaks. Because demand-response services are sensitive to wholesale power prices, higher natural gas prices should help demand-response companies. In fact, higher natural gas prices today improve long-term fundamentals for all demand-response companies.

The important point is that for independent power producers, overall fundamentals have not changed significantly. Year over year, power producers will continue to experience headwinds. The long-term outlooks for thermal coal and nuclear power appear unchanged.

Some Real Money subscribers shorted power producers. They noted Exelon's miscalculations in the power markets. They also noted confirmatory surprises in PJM Interconnection's capacity auctions. They combined the two issues and saw an opportunity to short power producers. Up until now, shorting independent power producers was a profitable position.

This may be a good time to cover shorts and book profits. The timing is in advance of expected news of increased demand, higher power prices and improved revenues for power producers. If short positions are not covered soon, investors may find their gains erased.

Investors can consider returning to their short positions in early August. Most of the good news for independent power producers will have been written. Many will expect more good news to follow. Unfortunately, those expecting more good news will find independent power heading into a slowdown.

The reason is seasonality. Energy consumption is seasonal. Spring and autumn are the seasons when demand is the lowest and when energy consumers usually spend the least. These are the times when large power plants shut down for preventive maintenance. It is also when nuclear plants prefer to exit the market for refueling.

Source: EIA/Williams

The graph shows the seasonality of natural gas and electric power. Natural gas begins its second peak in June, which in turn drives up power prices.

For investors relying on near-term fundamentals, near-term news is one reason why shorts should be covered now. The news from each energy season precedes normal reporting events. Making fundamental analysis more challenging is the company's quarterly reports; they are not positioned well in time with the industry's energy seasons. As such, the short-term news will not necessarily track well with quarterly filings.

Looking at the curves, Real Money investors have an opportunity to position themselves in front of the news. When the news hits, it will be time to consider reversing positions.

Some investors may want to combine this knowledge of fundamentals with technical analysis offered by colleagues at Real Money Pro. The combination could help investors time their exits and reentries to increase profits.

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