Excellent article!!!
RRI's day is coming a lot sooner than most are predicting.
Jim
POWER POINTS : Spot Market Fires Warning Shot At Bears
By MARK GOLDEN
A Dow Jones Newswires Column
NEW YORK -- The glut of U.S. power plants, which some experts said would last from 5 years to 10 years, disappeared in just a few days in much of the country earlier this week.
The profitability of a new, efficient gas-fired turbine in Texas soared to a stunning $143 a megawatt-hour for the 16 on-peak hours Wednesday from a very healthy $39/MWh Tuesday and just $5/MWh a week earlier. Across the western U.S. on Wednesday, the "spark spread" - or difference between wholesale electricity prices and spot fuel costs - for a new gas-fired turbine averaged $44/MWh.
The spike must have given a bit of relief to the builders of new, merchant power plants like Calpine Corp. (CPN), Mirant Corp. (MIR) and Reliant Resources Inc. (RRI), which have suffered from low power prices for more than a year. It takes an average spark spread of $14/MWh over the course of a year for a new power plant to cover operating costs and debt service if it's running during weekday on-peak hours only, according to industry consultant Cambridge Energy Research Associates, or CERA. An average of $24/MWh provides a 15% return on equity, which would make owning a power plant worthwhile.
So Wednesday was a brief break in the dark clouds for producers, who need only a few days of spark spreads over $100 each quarter to keep the banks off their backs.
Nevertheless, most analysis of the U.S. merchant power sector is extremely bearish.
"We are currently one year into a minimum five-year down cycle, characterized by lower power prices, decreased volatility, and squeezed spark spreads," CERA said in a report earlier this month.
According to the few industry bulls, like energy stock analysts Lasan Johong at investment bank Blaylock & Partners and Chris Ellinghaus at Williams Capital Group, the consensus is flawed. Electricity bears count up the capacity of all generators and wrongly deduce overcapacity, according to the bulls. In fact, in most of the country a lot of old, inefficient gas-fired and oil-fired generators give the appearance of excess capacity even though they won't ever run again.
The key point that has been missed: A glut of old, inefficient turbines doesn't mean there's a glut of new turbines. In southern California, for example, a new plant has been earning about $15/MWh on average so far this year. A moderately inefficient plant, on the other hand, has earned an average of $1/MWh. The oldest plants haven't run at all.
"The semi-reality of excess capacity is diminishing," said Ellinghaus.
"I'm not saying there isn't excess capacity. There is, but it's shrinking," said Ellinghaus, who returned power producer Calpine to a "buy" recommendation last April. He now considers that move premature but still fundamentally correct. Williams Capital hasn't done any banking transactions with Calpine, though it has had discussions with the company in the past, Ellinghaus said.
"Calpine will be the darling of the world in three years maybe, in four years for sure," he said. "They'll be making so much money, it's not even funny."
The retirement of the oldest power plants, which are generally owned by regulated utilities, would reduce overcapacity from around 30% to 20%, figures Ellinghaus, who added that retirements are happening.
"Five companies have announced mothballing plants," he said. "That's five more than I've seen in my entire career."
Granted, the spark spreads this week were an aberration. Neither prices the past year nor forward market prices indicate anything close to the $24 spark spread for a sustained period that plant owners need. But prognoses by CERA and others of a long-term glut seem undercut by how quickly an electricity shortage developed this week with a bit of cold weather.
Though Northeast gas-fired plants couldn't earn any profit Tuesday or Wednesday because power prices didn't keep pace with soaring natural gas prices, by Thursday owning a new power plant almost anywhere in the country was quite profitable.
This during winter, which for the country on average is a low-profit period for electricity producers, in the midst of a general glut. For January and February, on-peak spark spreads for new plants averaged almost $13/MWh in the West, almost $11 in Texas, $9.50 in the Northeast, about $6.50 in the Midwest and $5.50 in the Southeast, according to Dow Jones Newswires' daily surveys.
Johong expects the national average spark spread this summer to be $12-$16/MWh, which is above current forward prices for the country as a whole.
"Forward spark spreads reacted a little bit to the spot market this week," said Johong.
"People are waiting to see what happens, but spark spreads are rising gradually," said Johong, who has "buy" recommendations on AES Corp. (AES), Calpine, Mirant, and recently on Reliant. Blaylock doesn't have any banking relationships with these companies.
Soaring gas prices have improved spark spreads and the outlook for power producers. Every day, utility buyers work their way up the supply stack, buying power from the cheapest source first until they have locked up enough electricity to meet the next-day's expected demand. Typically, they end up having to use some generators with a heat rate of around 10, which implies that a plant requiring 10 million British Thermal Units of gas to produce 1 MWh of electricity set the market price. For companies that built new seven heat-rate plants, profits are the difference between seven and, say, 10 multiplied by the wholesale price of gas. In that market, the 1990's gas price of around $2/mmBTU yields a spark spread of just $6/MWh, but gas at the $8 seen lately gets a spark spread of $24.
"Unless you think gas is coming back to $3, you're probably not going to see the $6-$8 spark spreads everybody is taking about," said Johong.
That dynamic holds even if electricity demand is stagnant. In fact, electricity consumption during the past 52 weeks has risen 5.7% from the year before. To the degree that new plants are running more often, the average hourly spark spreads they need to survive declines.
Bears ought to keep in mind the market rule of "reversion to the mean." Just as the outlook for merchant power was painted too brightly in 2000, so it may be a bit too dim now. At least, with spark spreads even momentarily shooting into the stratosphere, it seems crazy to short the stocks of these companies at their current rock-bottom prices |
