It took some time, even during a recent heat wave that saw multiple days of high demand and price volatility, but the forward curve is finally starting to rip. The mild spring and bearish CDR report (at least the market thought so), left a lot of ground to make up to get back to highs from earlier this year – but 2020/2021 forwards have almost fully recovered (2022 less so). Month-to-date on-peak forwards are now up ~18% in 2020 and ~8%/3% in 2021/2022. This is what ultimately matters for the stocks, as it allows incremental hedging at more attractive prices. For reference, both NRG and VST are 70% hedged in ERCOT for 2020 – leaving ample open capacity.
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Momentum has no valuation ceiling while risks and uncertainties have no valuation floor. This is the story within utilities and among the market overall. A choppy Q2 due to unfavorable weather and weaker core sales growth seemed to only exacerbate this trend. A few companies appear to be re-rating on lower risk perceptions – ETR, FE, EVRG, SO, EIX, SRE – but otherwise we continue to see more divergence between the pure play safe regulateds vs those with diversified businesses or project/regulatory risk. Given our value focus, we are resigned to keep focusing on the messy ones.
More recently we’ve received questions on the difference between Vistra and NRG. To be clear, we like both given similar investment propositions – integrated low cost operations, backed by robust free cash flow generation and strong balance sheets. Both companies are anchored by premier Texas retail operations, with ~50% of total generation capacity also in ERCOT. That said, the companies also have differences in strategy and make-up, which may draw different investors.
Last week we saw PEG, EXC, and VST all report Q2 earnings – with solid financial results across the board. Looking at recent stock price performance, you wouldn’t think that was the case however. The commodity price environment has remained challenging, though hedging has protected near-term impacts. The companies mostly pointed to a lot of the same pricing drivers – mild weather, weak natural gas and CCGT new build financing in PJM (and related revenue put option activity). Both EXC and PEG seem to be tracking modestly behind typical ratable hedging pace further out – reflecting a skewed positive view on PJM pricing from here. VST mgmt. was adamant that it didn’t agree with where forward curves are currently trading, though it is prepared to maintain its $3B+ annual EBITDA outlook in the current pricing set-up. The company believes there are more coal shutdowns to come in ERCOT and that CCGT new build in PJM is uneconomic right now.
Quietly our Wolfe Yieldco Index has become the top income sector YTD and the only one beating the S&P 500 (see Ex 1). Yieldcos have overcome the huge uncertainty caused by PCG’s bankruptcy filing in January. Why have they done so well? 1) long-term contracts that are not subject to ROE resets like utilities so should benefit directly as interest rates fall; 2) the neighborhood improved meaningfully as parent companies changed from distressed owners to higher-quality parents (SunEdison to Brookfield, Abengoa to Algonquin, NRG to Global Infrastructure Partners); 3) Its Renewables stupid – the top growth space in energy with huge economic and tax subsidy momentum. While we are a bit wary of competition and financial discipline in renewables, we think the backdrop remains bullish. There is no better way to play all of this than NEP given their connection to industry leader NEE, huge growth backlog, cost-of-capital advantages and visibility on 15% dividend growth for at least the next 5 y
This week kicks off earnings for the power names within our coverage – PEG, EXC, and VST all report (NRG is next week). A lot has changed since Q1 reports – it hasn’t been pretty.
This afternoon (7/25/19), FERC issued an order directing PJM not to run its annual capacity auction in August. PJM had requested that FERC either provide guidance or refrain from making any changes retroactively in the event the auction was run and then FERC decided to change the rules. We had been pointing to the PJM auction as a negative near-term catalyst and overhang for the generators, given what appeared highly likely to be a much lower pricing outcome driven by new build and more subsidized generation (ie: OH nukes). Now FERC will continue work to revise PJM capacity auction rules to address both state resource preferences and price suppression. While we don’t know the exact structure, we think there will be interest in supporting existing coal/nuclear assets.
We refreshed our Wolfe power price deck in accordance with our earnings preview published yesterday (07/22/19). Given the significant sell-off in virtually all forward power prices, we lowered our assumptions across the board and are now more closely aligned with market pricing. One exception is in PJM, where we are modestly above market prices given the extreme collapse in pricing and our sense that the skew from here appears biased to the upside. Given most generators are almost fully hedged in 2019, the impact near-term was very modest and we expect each company to reaffirm guidance. However, 2020 and beyond estimates were hit hard – particularly for VST. For now, our published estimates are slightly ahead of MTM due to the impact of higher PJM price assumptions on unhedged CCGT capacity.
We have seen big performance dispersion in the sector this year and widening valuation spreads. What value names can finally wake up? CA legislation should continue to benefit EIX/SRE and the associated Yieldco names NEP and CWEN (still on sidelines on PCG). We think FE can finally get past FES and NI can hopefully move past Columbia MA. SO will have a key update on the Vogtle plant from PSC staff (which tends to have a cautious bias); other project risk stocks DUK, D, AGR likely stay in limbo for now. CNP and EVRG will be focus names on whether they can rebuild credibility in hitting numbers. PNW and ED likely stay pressured by regulatory overhangs. And then there’s Power, which we think stays under N-T pressure into the August PJM auction even as we expect the companies to reaffirm 2019 outlooks.
Last week was the first time that power prices trended in the right direction in quite a while. In ERCOT, the forward curve was up a few percentage points in 2019/2020 and little changed further out (though it has held up relatively well), while real-time/day-ahead markets showed some signs of life. As temperatures pushed higher and load got within 3 GWs of last year’s record (73.3 GWs), there were several brief periods where pricing got well into the triple digits (peaking at ~$600-700/MWh). This week, temperatures are forecast to rise towards seasonal norms in the upper 90s. The Mid-Atlantic also finally heated up and perhaps saw a moderation in forward hedging activity, driving higher gas prices, and seeing the PJM forward curve rise over 5% across 2020-2022 (2019 was up modestly). There’s still a long ways to go to reverse weeks of power price pressure, but for once our mark-to-market estimates are going up and not down.
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