The winter's polar vortex has provided investors with an unexpected earnings vortex. Last week, Entergy (ETR) reported the happy outlook of increased earnings. Exelon (EXC) and NRG Energy (NRG) should follow suit. While it is good news, nobody is announcing changes in industry fundamentals. In fact, it is just the opposite. A stubborn surplus of generation in the power markets remains. That surplus has to be addressed before good times can return.
First, let us look at the good news. Last week, Entergy published an early outlook for first-quarter earnings. It also took the opportunity to announce an increase in 2014 expectations. Entergy's announcement was impressive. It expects first-quarter earnings to exceed $2.20 per share, which is about $1.30 higher than the previous year. In addition, it raised its 2014 outlook to $5.40 from $4.60 per share to $5.55 to $6.75, up about $1.20 per share.
It appears the market is anticipating similar news from Entergy's competitors. Since early January, Exelon stock is up by approximately 30%. Meanwhile, Calpine (CPN), Entergy and NRG are all up by 11% to 15%.
But be careful. These earnings are one-time events. They do not represent any fundamental change in the industry. In fact, the same structural challenges that were present in 2013 remain.
Here is what happened. Natural gas was largely responsible for first-quarter earnings. Pipelines were constrained. Because gas could not reach their markets during the polar vortex, citygate prices shot through the roof (citygate prices are delivered prices for wholesale gas). When prices jumped, other fuels became very profitable. Consequently, power plants that used coal, nuclear, hydroelectric and renewables profited from pipeline limitations.
Constraints in pipelines cannot be resolved quickly. Any time pipeline constraints appear, local power producers will likely profit, particularly power generators that do not need spot natural gas. Not all natural gas pipeline segments were constrained during the vortex. Some states are near gas wells. Other regions depend on other fuels for power generation.
Nevertheless, these other regions also saw power price spikes during the vortex. The extreme weather drove consumers to increase demand, which forced high-cost producers into the power markets. The involvement of high-cost producers caused power prices to spike. It is important for investors to understand the polar vortex was a one-time event. Of course, there may be other one-time events in the future, but companies like Entergy and Exelon cannot count on them.
It turns out most do not. Most are adjusting the annual outlooks only by the amount gained in the first quarter and no more. In fact, it appears Entergy made room for some downside for the second through fourth quarters.
Fundamentals Are Unchanged
The industry continues to face one stubborn fact: Outside the Washington D.C. to Boston corridor, too many power plants are competing in those markets. When there is too much supply and limited demand, prices drop.
We were hit with this reality just a couple of weeks ago. The Midcontinent Independent System Operator (MISO) reported a surprising surplus of power generation. The effect on the markets was not so surprising. MISO is the nation's largest grid. It stretches from southern Manitoba to Texas and from eastern Montana to Indiana. For the energy year 2014-2015, MISO needed 136,912 megawatts of capacity, which is 2,500 megawatts more than the previous year.
Incredibly, MISO received bids for all that capacity and more. In fact, more than 12,200 megawatts failed to clear MISO's auction. This surplus is 50% greater than the previous year. All 12,200 megawatts of capacity met federal and state environmental requirements. Apparently, they are compliant but not cost competitive.
They are not alone. Similar results popped up last year in the neighboring PJM Interconnection. The Northeast has tight capacity, but their auctions do to appear to reward successful bidders.
Cash-strapped generators may decide to exit. High on the list will be oil and coal-fired plants. It will also include nuclear plants. In fact, several nuclear plants could be exiting. It is about year-round economics. On quarterly basis, some units struggle to contribute earnings while others are believed to be cash-flow negative.
There is one case where a private company may seek bankruptcy protection. It is expected to take place within days or weeks. Among other assets, the bankruptcy may involve a large nuclear plant and a number of coal plants. If it happens, it will be big and it will likely spook the market.
Keep a firm hand on the tiller. If you have a position with Entergy, now might be a good time to exit. If you have a position with Exelon or NRG, expect turbulence ahead.