After close on 11/25, a CPUC ALJ issued a proposed decision in the Cost of Capital applications, which will set allowed returns and capital structures for each CA utility’s respective state-regulated rate base in 2020-22. The ROEs would be unchanged for EIX (10.30%) and PCG (10.25%). SRE’s SDG&E electric would get 10.20% vs 10.15% currently. EIX’s SCE would get a 52% equity ratio (vs 48%) – in line with the other two utilities. Balancing fire and inverse risk against a lower interest environment, we see the PD as in line with expectations. The ROEs would be close to the midpoint between the utilities’ requests and intervenors’ recommendations: 115-220bp increases due largely to wildfire risk vs 150-185bp decreases. And the political backlash from recent shutoffs does not appear to have significantly impacted the PD.
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This morning, it was announced that Dutch energy company Eneco would be purchased by Mitsubishi (80%) and Chubu Electric Power (20%) for $4.1B Euros. This followed a sale process that kicked off almost a year ago, which garnered interest from the likes of Shell, KKR, Macquarie, and EDF as well (Total and Enel dropped out earlier). This got us thinking. Asian investors have already shown a keen interest in U.S. power plant investments, as seen by the readily available financing in CCGT new build. Why couldn’t one of these foreign power companies buy a U.S. IPP? Granted, Eneco is a bit different, in that it has a quasi-regulated gas and electric retail business, as well as growing investments in renewable energy that includes offshore wind. But clearly there is an interest here to diversify out of Asia. When we published our annual power supply update back in September, the number of Japanese and Korean utilities investing in U.S. gas plants was endless.
We’ve now been waiting 17 months for FERC to decide on new PJM capacity auction rules since determining its tariff was unjust/unreasonable. There have been a few false starts, but with Commissioner Glick’s recusal on the issue set to end on 11/29 and James Danly’s nomination as commissioner moving one step closer this week, we feel as though an actual order is finally upon us. In this note, we’re simply reviewing exposures to hypothetical scenarios. At the end of the day, it’s probably fair to say that EXC and VST have the most at stake here. However, it’s important to note that the PJM capacity auction is simply not as important as it used to be. EXC has the most capacity in PJM and addressing its subsidized (and non-subsidized) nuclear plants is critical in how this plays out. VST has the second most capacity in PJM, with about 25% of its EBITDA coming from energy/capacity revenues combined in the region.
FERC issued an order today in two MISO transmission ROE complaints, setting a methodology that differed from its last proposal, establishing a 9.88% base ROE and dismissing the last of the two complaints. That 9.88% base is lower than the 10.3% that FERC set a few years ago under a methodology that has since been vacated. FERC did not rule on the four New England ISO ROE complaints, as Comm. Glick – one of the three seated FERC commissioners (two vacancies) – cannot vote on those. But that base ROE also likely would decline under today’s order. Transmission makes up less than half of earnings for the impacted utilities (FTS and ES almost 40%, AEE 20%). To the negative, the base ROEs are now under 10%, which optically looks bad, given they were around 12% earlier this decade and are now in line with the 9.7% average awarded at the state level. But the MISO names will still earn about 10.4% – when including the 50bp RTO/ISO adder.
There were two major growth updates with Q3 results. First, sponsor GIP back-levered the Carlsbad plant, reducing the purchase price for CWEN to a much more manageable $180M from $387M. Terms were very attractive and increased the equity return to 15% from 10%. An acquisition of Carlsbad is likely by 1H20. On the negative side, CWEN will pass on the planned acquisition of Mesquite Star in order to prioritize capital toward Carlsbad during a period of PG&E-related capital constraints. Updated financing plans for major near term acquisitions – the wind repowering and Carlsbad – imply only $65M of equity needs. So there is a visible plan in place for CWEN to grow over the next 6-9 months while only needing modest equity likely through the ATM. This is positive while customer PCG remains in bankruptcy.
After a long headline-filled year, the S&P 500 broke out to new highs last month and caught up to utilities, both up a little over 21% through October. The market has climbed a wall of doubters, while our recent poll shows utilities continuing to gain investor support. From a contrarian standpoint, we take the market. Investors have been leaning defensive most of the year such that a typical year-end defensive trade seems unlikely. In fact, the defensive trade over the past few weeks has been to buy depressed value stocks and cyclicals. Utilities still trade at a 17% premium to the market and we would like to see them closer to the average to be more constructive.
We are downgrading CWEN stock to Peer Perform from Outperform and lower our target price to $19/share from $21. The Kincade fire has complicated key customer PCG’s expected June 2020 emergence from bankruptcy and increased uncertainty for CWEN stock – see our industry note here. We still believe CWEN’s PPAs with PG&E are likely to be retained, but there could more concerns due to the new fire claims. PG&E accounts for roughly 30% of CWEN’s consolidated cash available for distribution. A delay in PCG’s bankruptcy process at the very least delays the likely timing of cash traps being resolved and of CWEN reinstating its prior dividend level. To the extent CWEN’s stock is adversely affected by the uncertainty, it also could reduce equity market access and delay CWEN’s ability to resume material drop-down acquisitions in an accretive fashion.
It may have went under the radar, but last week FES reached a settlement with labor unions in its pending bankruptcy proceeding – resolving all issues and filing for approval at a hearing tomorrow (10/15). FES assumes all collective bargaining agreements in the settlement. We now expect the plan of reorganization to be confirmed by the judge. Once complete, the only remaining step before FES can emerge is the NRC licenses transfer for its nukes. FES filed for approval in late-April, with this typically taking 6-9 months. All appears to be on track to emerge by year-end – about one year after the last power generator came out of bankruptcy (GenOn).
Wolfe Research's Senior Utilities & Midstream Analyst Steve Fleishman hosted a webcast to discuss PCG implications, CA outages, MO regulation post-Sibley, FTS initiation, EXC and IL, election trade, and DUK legislation in NC.
Wolfe Research's Senior Utilities Analyst Steve Fleishman hosted a webcast to discuss post-conference takeaways.
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