Utilities Are Hot for Summer

 | Jun 23, 2014 | 6:00 PM EDT
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The power industry is entering its big energy season. This is when investors expect the greatest revenues and margins. This summer could provide the final decision for many power plants. Coal-fired power plants need high prices to justify continuing operations. The same is true with many nuclear and natural gas units. Wind and solar also hope for higher energy prices.

Three factors contribute to higher demand, prices and revenues. The first is heat. Heat motivates higher demand. This is the time of year consumers turn on their energy-hungry air conditioners and keep them on. The demand grows as new loads arrive. Consumers keep their homes air conditioned even when they are at the office or on vacation. June is when vacation properties come alive and draw huge amounts of additional power. The hotter it gets, the more consumers need cooling, thus the greater the demand. Higher levels of demand lead to higher prices, which lead to the second factor.

State regulators create complex price structures in large documents called tariffs. Typically, these price structures provide regulated utilities with higher prices for their energy in the summer. The policy argument is that heating is a life and death issue in the winter, therefore, prices should be as low as possible. The summer is different: Cooling is not essential for survival.

Higher prices lead to higher revenues. The hotter it gets, the greater the demand. Higher demand times higher prices lead to higher revenues. But there is another way to achieve higher revenues, which leads to the third factor.

This week is when the days are longest. It may not be hot, but there are a lot of hours of sunshine. The days and weeks around the summer solstice are pure gold for the solar power industry. Solar power does not care about temperature. All solar cares about is sun. When there are more hours of sunshine per day, there are more hours of production. More hours mean more revenues.

The loser in many areas is wind. Along the East Coast, wind tends to be strong in the winter and weak in the summer. Owners of eastern wind-power plants expect higher prices but lighter revenues. Texas and the Rocky Mountains may be different.

To be blunt, utilities hope for a strong economy and high temperatures. In particular, Exelon (EXC) would like to see the Midwestern economy churning and burning. If it can book enough revenue at high enough margins, perhaps some of its nuclear plants will live to see another year.

The same is true with Entergy (ETR). It has regulated and deregulated nuclear plants. Its deregulated plants need high market-clearing prices with better than breakeven margins. If it is a cool summer, some of its units may have profitability challenges.

NRG Energy (NRG) and PPL Corp. (PPL) own a lot of coal-burning assets. Like nuclear power, coal essentially has fixed production costs (coal prices are stable and heat rates are fixed). Higher market-clearing prices mean higher margins and a possible life ring for some marginal coal units.

Natural gas is very different. Higher prices do not necessarily mean higher margins or profits for gas turbines. Because gas turbines are usually on the power market's margins, spark spreads are the key to gas turbine profits. Spark spreads are the difference between the price of natural gas delivered to the power station and the price of power at the station's transformers. The more efficient a plant uses natural gas, the greater the spark spread and profit. To assure a strong spread, efficiency becomes a critical success factor.

The most efficient gas turbine is a combined cycle. Calpine (CPN) owns more combined cycle gas turbines than any other merchant power producer. Nevertheless, higher prices could help Calpine. As prices increase, more of its marginal units will dispatch and those units will contribute to the fleet's margin.

For regulated utilities, higher prices will have mixed affects. About 19 states have enacted some form of decoupling. This means utilities operating in Vermont, Massachusetts, Rhode Island, Connecticut, New York, Maryland, Ohio, Michigan, Wisconsin, Washington, Oregon, Idaho, California, Arizona and Hawaii decouple utilities' recovery of fixed costs from sales. Maine, Minnesota and Arkansas are in the process of decoupling.

This means a long, hot summer is good for the remaining states; specifically, Dominion Resources (D), Duke Energy (DUK), SCANA (SCG), Southern Co. (SO), NextEra Energy (NEE), TECO Energy (TE) and most every utility in the central states will profit from hot weather.

If you think it will be a long, hot summer, Dominion and Duke might be for you. If you believe the summer will be mild, Consolidated Edison (ED), Northeast Utilities (NU), Edison International (EIX) and Pinnacle West (PNW) might be safe plays. The challenge will be forecasting the temperature.

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