The sell-off in IPPs has continued – NRG and VST are both down over 10% in May. The situation has been exacerbated by last week’s ERCOT CDR report. At this point it’s beyond an overreaction and bordering on irrational. We think it’s helpful to provide better context on the CDR, namely that the threshold for capacity inclusion is relatively low. While the report saw 5.6 GW of renewables additions and reserve margins popped up 3%/year in 2021-2023, this merely indicates an interconnection agreement is in place. In reality, many of these projects fail to reach operation.
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Utility earnings rose 5.0% in Q1, slightly above our 4.9% estimate. No companies changed guidance for 2019 but the same companies that disappointed at year end had issues again such as AGR, CNP, and NI (not EVRG, phew). Earnings quality stuck out to us as weak with tax or other gains driving numbers at SRE, DUK, NRG among others. AEP may have been the most incrementally positive with increasing confidence in the upper half of their 5-7% growth rate. Mega project risk continued to overhang D and DUK (ACP) and SRE (more Cameron delays), though SO kept Vogtle on schedule (for now). Finally, weak renewables conditions hurt in Q1 causing misses at AGR, CWEN, and NEP, but the influence of renewables keeps accelerating overall.
We’ve pointed to a few potential items as likely driving weakness in the IPPs over the last few trading sessions. For NRG, it may have been the slow start to the year relative to expectations and a sizable portion of its current buyback authorization already being used up ($750M). For VST, we believe it was tied to a stock trading dynamic related to selling shareholders, consistent with prior quarters on the day when the company reported. To those points though, we see NRG as still having $500M left of its current repurchase program, with the potential for another $1B on the come. For VST, we expect 13-F filings next week to show reduced ownership stakes for the selling shareholders – helping to remove an overhang as their exits come nearer.
The NJ BPU’s decision on ZECs was a little too close for comfort for some investors. However, PEG now has locked in ZECs and capacity revenues through mid-2022 at Power, along with a 5-year rate case stay-out at PSE&G – adding relative certainty to the long-term outlook. The stock has basically traded sideways since the ZECs decision. We think this removed an overhang and the low-risk investment proposition going forward is compelling. Price Target remains $65. Outperform.
Utilities rose only 0.9% in April, while the market rallied another 3.9%. Utilities are now underperforming the market by roughly 670bps YTD; they have given back their entire 2018 outperformance. So, what should investors do now? The stock market rally in 2019 is becoming historic - this is only the 3rd time in the last 40 years the S&P 500 rose more than 15% in the first 4 months. One of them ended badly - the 1987 crash during which utilities outperformed. The other year was 1983 - the market flattened out the rest of the year while utilities continued to underperform. We also looked at years where utilities underperformed 650bps or more in the first 4 months as well. This has happened 16 times in the last 40 years. Interestingly, 10 of those 16 years utilities continued to underperform into year-end by an overall average of 200bps.
We’re previewing Q1 earnings for the power names this week – with NRG, EXC, and PEG all reporting Thursday; followed by VST on Friday. Guidance ranges for the year look to be on track. Focus topics will be the status of the PJM capacity auction and the upcoming ERCOT summer for the IPPs; and New Jersey ZECs aftermath and IL/PA legislative prospects, for PEG and EXC respectively.
Last Thursday (04/18/19), FERC passed fast start pricing changes in PJM with implementation expected by July 31. On the surface, the changes appeared watered down somewhat relative to PJM’s proposal, but were a positive step forward in the price formation initiative nonetheless. At a high level, the change is expected to allow for prices to more accurately reflect the marginal cost of serving load. That said, the PJM forward curve actually was unchanged on Thursday, and is modestly down since the FERC agenda including the fast start docket was initially posted. This seems to indicate that the change was already reflected in forwards or was insignificant (or both). We remain hopeful that the broader price formation initiative, expected to play out over the course of 2019, will yield more meaningful changes. Finally, we also found it noteworthy that FERC decided to take up this issue before capacity market reform. Clearly, resolving the capacity market debate on handling subsidized units is more time sensitive given the upcoming August auction. Perhaps this suggests there simply isn’t a majority vote to do anything on that front at this point.
Today (04/18/19), the New Jersey BPU voted 4-1 (order) to award ZECs to PEG’s three nuclear units – Hope Creek and Salem 1/2. While approval was widely expected, the decision had become much anticipated after PEG mgmt. raised some caution as to whether all three units would be awarded ZECs. That scenario would have been very negative, given PEG committed to shut its nuclear fleet and forego the ZECs (as well as energy and capacity revenues). Despite opposition from the ratepayer advocate and lack of full BPU Staff support, these nuclear plants provide nearly all of the state’s emissions-free energy, which closely aligns with Governor Murphy’s clean energy agenda.
This Thursday (4/18), the New Jersey BPU is set to vote on zero emissions credits for PEG’s (and EXC’s) nuclear units in the state. Recall that ZECs legislation was signed into law by Governor Murphy last May and maintaining the nuclear units appear to be a big part of his vision for a cleaner energy future. That said, this is still subject to BPU approval every three years. We estimate the subsidy is worth about $300M in total – ~$0.30/sh for PEG and ~$0.06 for EXC. PEG mgmt. has been very clear that in the event that any of its nuclear units fail to qualify for ZECs, it will shut down the entire fleet. We view approval as highly likely, given its alignment with Governor Murphy’s plan. However, PEG mgmt’s cautious tone in investor meetings earlier this year likely caused some concern, such that the stock likely sees a small relief rally if ZECs are approved.
PJM’s Market Implementation Committee will hold a meeting 4/10, during which PJM’s President will discuss PJM’s path forward for the 2022/23 Base Residual Auction. The auction, which sets capacity prices 3 years out for the 12 months beginning 6/1, has already been delayed from May to Aug 2019. The delay was to allow for implementation of FERC’s rule on PJM’s capacity tariff. Last year, after PJM and others submitted proposed changes, FERC found the existing tariff unjust and unreasonable and has since been considering how to structure the capacity market given subsidized unit bidding. FERC is short one commissioner, another is relatively new (McNamee) and another’s term expires this summer (LaFleur); it is unclear when an order will be issued. On 4/10, PJM is expected to decide whether it should again delay the auction, run it under the previous rules, or run it under PJM’s alternative rules proposed last year. Last week, member companies (EXC, PEG, NEE, D, TLN, AGR) with most of the capacity in PJM requested that PJM take steps to delay the auction until mid-April 2020, prior to the 2023/24 auction.
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