• Subscribe
  • Log In
  • Home
  • Daily Diary
  • Asset Class
    • U.S. Equity
    • Fixed Income
    • Global Equity
    • Commodities
    • Currencies
  • Sector
    • Basic Materials
    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financial Services
    • Healthcare
    • Industrials
    • Real Estate
    • Technology
    • Telecom Services
    • Transportation
    • Utilities
  • Latest
    • Articles
    • Video
    • Columnist Conversations
    • Best Ideas
    • Stock of the Day
  • Street Notes
  • Authors
    • Doug Kass
    • Bruce Kamich
    • Jim Cramer
    • Jim "Rev Shark" DePorre
    • Helene Meisler
    • Jonathan Heller
    • - See All -
  • Options
  • RMPIA
  • Switch Product
    • Action Alerts PLUS
    • Quant Ratings
    • Real Money
    • Real Money Pro
    • Retirement
    • Stocks Under $10
    • TheStreet
    • Top Stocks
    • Trifecta Stocks
  1. Home
  2. / Investing
  3. / Energy

Three Forces Squeezing Energy Profits

Energy efficiency will become a major competitor.
By GLENN WILLIAMS
Apr 12, 2013 | 05:30 PM EDT
Stocks quotes in this article: HON, ITRI, ENOC, XEL, NEE, DUK, EXC, ETR

Generating utilities are experiencing an unprecedented squeeze on margins. Wholesale power prices have fallen off the cliff and it appears average prices will remain low for the foreseeable future.

Of course, there will continue to be price spikes. Price spikes into the hundreds of dollars will appear for a few hours on hot summer days. Price spikes will be newsworthy in regions like New England, Texas and California, where there is a capacity shortage. Investors should not overreact to these spikes. For the most part, they no longer matter.

Price spikes only make a dent in a generator's earnings. Power generation is a round-the-clock operation where high prices are offset by low prices. The average price will dictate earnings.

In 2012, the average price of wholesale power fell. There are several reasons for the decline. The biggest is deregulation and the emergence of power markets. Hundreds of times each day, these markets match energy supplies with consumer demand to set market prices.

For generating utilities, energy supplies have been growing while demand has been falling. See graph:

Source: EIA

Many commentators claim the source of the problem is cheap natural gas. It is a factor. But the graph tells a different story. Energy production decreased as generating capacity increased. To make matters worse, it appears consumers are not responding to lower price signals by consuming more.

Appearances are deceiving. Consumers are responding to market signals. There is a lot more going on under the hood other than natural gas. In fact, there are three simultaneous forces at work, all of which affect power markets:

  1. Energy markets
  2. Energy efficiency
  3. Renewable energy

In North America's ten deregulated markets, wholesale power prices for power are set by market auctions. When supplies meet demand, a price is set and all successful bidders earn that market-clearing price. The market constantly rewards the cost efficient and punishes the inefficient, which puts downward pressure on wholesale energy prices. As these markets mature, the pressure to lower prices will only increase.

Under new Federal Energy Regulatory Commission rules, energy efficiency prices are also set by the power markets. In fact, energy efficiency competes directly against power plants and power plants compete directly against energy efficiency.

This new arrangement seems odd. To help understand the market, consider the fact that under FERC rules, energy efficiency has become a commodity that will trade in the power markets.

It gets more interesting. The intent of FERC is that the energy efficiency commodity will become completely fungible with the energy commodity in the markets. That is one of the ideas behind the installation of smart meters.

In fact, for capacity-starved regions like the Northeast, Texas and California, energy efficiency is the only practical answer to the troubling question where to attract new generation. The answer is they do not need to attract new power plants; energy efficiency and the markets should shave demand and peak prices. This will have the effect of adding virtual supplies and reducing prices.

Energy efficiency is not the only actor that helps keep prices low. Real Money readers already know wind and solar power resources reduce market-clearing prices because they, like energy efficiency are cost leaders (not necessarily price leaders.) Markets reward cost leaders. As such, energy efficiency, wind and solar resources will only grow over time and keep market pressure on the traditional generating utilities.

Lower prices mean businesses, residential consumers, states and regional markets win. Companies like Honeywell International (HON), Itron (ITRI), EnerNOC (ENOC), Toshiba and privately held companies offering energy efficiency technologies, equipment and programs also win.

Investors should avoid manufactures of renewable energy equipment and focus on companies that own wind and solar farms. Owners of wind and solar farm are making solid returns. This includes Xcel Energy (XEL), NextEra Energy (NEE), Duke Energy (DUK) and even Exelon (EXC).

Unfortunately, there are losers. Old-fashioned steam generating utilities are not cost leaders. An example is Entergy (ETR). Their merchant fleet of nuclear plants will be among the first to experience growing competition from energy efficiency in two grids: ISO New England and New York ISO. As wind and solar resources grow, wholesale prices Entergy uses to set margins will slide further. Lower margins mean lower earnings.

Investors should be skeptical when they hear utility executives argue that higher power prices will arrive in 2015. If a utility executive is looking to the past to predict the future, they are in for a big surprise. In the past, energy efficiency did not exist as a regulated commodity. In the future, energy efficiency will become a major competitor.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication the author held no position in the stocks mentioned.

TAGS: Investing | U.S. Equity | Energy | Utilities

More from Energy

At What Price Is Ballard Power Systems a Buy?

Bruce Kamich
Jan 15, 2021 3:09 PM EST

Let's check out the latest charts of BLDP.

Time to Nail Down Some Profits on Halliburton

Bruce Kamich
Jan 14, 2021 10:47 AM EST

Our latest technical analysis and trading strategy for the oil services stock.

A Rising Tide Is Going to Lift LNG Shippers in a Very Cold Winter

Jim Collins
Jan 14, 2021 10:30 AM EST

Also, my take on Jack Dorsey and Twitter, along with Facebook.

It's Only a Month, but This Deep-Value Portfolio Is Performing Quite Nicely

Jonathan Heller
Jan 11, 2021 10:30 AM EST

The aggregate return of the 2021 Double Net Value Portfolio one month since inception is outpacing a handful of Russell indices.

EOG Resources Has a Big Base and It Could Get Even Bigger

Bruce Kamich
Jan 8, 2021 2:31 PM EST

Bases in the energy market can take a long time to form.

Real Money's message boards are strictly for the open exchange of investment ideas among registered users. Any discussions or subjects off that topic or that do not promote this goal will be removed at the discretion of the site's moderators. Abusive, insensitive or threatening comments will not be tolerated and will be deleted. Thank you for your cooperation. If you have questions, please contact us here.

Email

CANCEL
SUBMIT

Email sent

Thank you, your email to has been sent successfully.

DONE

Oops!

We're sorry. There was a problem trying to send your email to .
Please contact customer support to let us know.

DONE

Please Join or Log In to Email Our Authors.

Email Real Money's Wall Street Pros for further analysis and insight

Already a Subscriber? Login

Columnist Conversation

  • 11:38 AM EST CHRIS VERSACE

    Best Stocks to Buy for the Biden Presidency

    President-elect Biden's massive stimulus plan, int...
  • 08:07 AM EST GARY BERMAN

    Wednesday Morning Fibocall for 1/20/2021

    SPX (Long-Term View) The 1/8/21 high @ 3826.69 i...
  • 11:09 AM EST GARY BERMAN

    Is Copper About to Turn to Rust?

    Below is a very long-term copper chart.  As you...
  • See More

COLUMNIST TWEETS

  • A Twitter List by realmoney
About Privacy Terms of Use

© 1996-2021 TheStreet, Inc., 225 Liberty Street, 27th Floor, New York, NY 10281

Need Help? Contact Customer Service

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

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.

FactSet 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.

Compare Brokers

Please Join or Log In to manage and receive alerts.

Follow Real Money's Wall Street Pros to receive real-time investing alerts

Already a Subscriber? Login