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June 17, 2008 – Comments (5) | RELATED TICKERS: FPL.DL2 , COP , XTO

Over the past several months, I have become increasingly fascinated with power companies.  I am working on a theory that power companies that have the ability to generate unregulated electricity from sources other than coal and natural gas (think nuclear, wind, etc...) will benefit as the prices of these resources continue to rise.

I like to thoroughly familiarize myself with how an industry works prior to doing any significant investment in it (this is why I haven't dabbled in biotech or pharma yet, way out of my area of expertise).  The more research I do on power companies, the more intrigued I become about the possability of investing in them. 

Demand for electricity in the United States is steadily rising, even though the number of power plants is not.  As early as 2009, the demand for power will exceed the current supply in Texas, New England, and much of the Western U.S.  Estimates state that this will happen by 2011 in the Mid-Atlantic and New York areas.

The price of electricity, which fell on an inflation adjusted basis in the '80s and '90s, has been rising rapidly since 2001.  Since the last oil crisis in 1972, the U.S. has done a great job at becoming more efficient in its use of oil, with domestic demand up only 15%.  However, the demand for electricity has increased by 115% over the same time period. 

The United States currently has enough power plants to generate 760 gigawatts of electricity and another another 154 in reserve capacity that is used to maintain the reliability of the grid.  This reserve capacity is being used more and more to keep up with the demand caused by heat waves, plant meaintenance, etc... 

According to estimates by the North American Electric Reliability Corporation, the U.S. will have to add 135 gigawatts of new power generation capacity over the next ten years to keep pace with our increased power consumption.  Yet only 57 gigawats of new power plants are currently in the planning stages.  Coal power plants, which generate relatively cheap electricity but pollute the environment (one doesn't have to look farther than all of the air pollution that we will see at the Beijing Olympics to see evidence of that) are being cancelled left and right.  Anti-coal crusaders supposedly have caused the cancellation of the construction of 59 coal plants in 2007 alone.

I am focusing my energy (so to speak, hahahah) on doing research on existing U.S. nuclear and wind power producers because I think that they will have a significant advantage if Obama is elected President (which I believe is inevitable.  If someone like myself really, really wants to like McCain, yet can't, he doesn't stand a chance.).  In my mind, a Democratic President, Congress, and Senate make the likelyhood of some sort of carbon tax being implemented pretty good.  If one is implemented, power companies that can produce power without carbon emissions will likely benefit.  Even companies that produce power from natural gas should do well, because its carbon emissions are half that of similar size coal plants.

A free embedded call option that I have been thinking a lot about lately is the most likely mass market solution to the current high gasoline prices that we are experiencing, plug-in electric hybrid vehicles.  A number of automakers are actively working on plug-in vehicles, such as General Motors' Chevrolet Volt.  I don't anticipate these cars going on sale before the year 2010, but if a manufacturer is successful in bringing out a viable plug-in vehicle, electricity demand will skyrocket and so will the profits of power companies.  If this happens, it will be far down the road.  I believe that the right power companies will be successful without it, but it is a nice bonus.

I have already purchased shares of FPL Group (FPL) and another power company that the TMF blavckout period prevents me from naming at this time.  I will continue to do research on this thesis and if I like what I see will likely add shares of these or other power companies in the future.  I don't expect explosive returns from these companies, but I do expect them to significantly outperform the S&P 500.  Plus they pay solid dividends as this theme plays out.

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The price of natural gas is closely tied to the discussion on power companies.  I expect the price of nat gas to continue to rise as a result of the increasing demand for power combined with the strong opposition of coal plants and the fact that no new nuclear power plant has been built in the U.S. in over 30 years.  Natural gas is currently used to generate about 20% of The United States' power.  As this percentage rises, its price will likely follow.  The use of natural gas in the mining of oil sands and in ethanol plants add to the demand for it as well.  Nat gas prices are already significantly higher in Europe and Asia than they are in North America.  I personally would not be surprised to see it trade over $20 in the U.S. at some point in the next several years.

I am long a number of natural gas producers in real life, including Apache Corp. (APA), ConocoPhillips (COP), Devon Energy (DVN), Marathon Oil (MRO), Penn West Energy Trust (PWE), and XTO Energy (XTO).

Argus just reiterated its "Buy" rating on ConocoPhilips this morning stating that it believes COP is attractively valued on both a relative valuation and cash flow model basis.  It likes COP's decision to increase its dividend and buybacks and it is very bullish on natural gas prices in general.  High prices are good for COP, given the fact that it is North America's largest producer of natural gas.

So that's where my head's at today.  Select power companies and natural gas.

Deej

Long APA, COP, DVN, MRO, PWE, XTO in nat gas

Long FPL in power

Forbes - Brownout

5 Comments – Post Your Own

#1) On June 17, 2008 at 4:46 PM, masterwill (< 20) wrote:

Informative post. Thank you for the insight. I agree with you completely.

My fear however, is not that power will out perform, I know it will. Just if there are any better investments for the near future. There isn't exactly excess money floating around to be thrown into a new nuclear power plant.

 I think foreign renewables and power are where the progress will be.

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#2) On June 18, 2008 at 2:32 AM, Tastylunch (29.42) wrote:

You know if you ever do want to try your hand at biotech, I'd reccommend checking out PDTBiotech's blog. He may not have the best CAPS rating but his knowledge of th at particular industry strikes me as pretty deep.

Of course HelicalZz is pretty dang good too.

Thanks for the informative post. 

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#3) On June 18, 2008 at 6:26 AM, TMFDeej (99.30) wrote:

Thanks for the tip, Tasty.  Perhaps some day I'll dip my toe in that area, for now I have too many other sectors on my plate.  The whole biotech thing has always seemed more like gambling than investing to me.  Huge upside if you hit, huge downside if you miss.  I could see investing in that sector if I was a doctor or a chemist with special knowledge, but since I'm not I would be relying too much on others' expertise and opinions for my taste at this point.

Deej

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#4) On June 18, 2008 at 12:23 PM, andrikos23 (< 20) wrote:

Deej,

I bet the other Power stock you cannot talk to us about is CHK. If it's not, consider that as a good long buy too.

Thanks for your insights.

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#5) On June 22, 2008 at 1:30 AM, awallejr (81.36) wrote:

Conceptually I agree.  Nat gas is here to stay.  Wind power has promise and for the life of me I don't understand why GE is taking such a beating.  I love that stock, for it's dividend, for its play in wind, amongst other things, and for the fact that the company isn't going to poof over the years.

I wouldn't, however, slam dunk Obama as next president.  He will win ONLY if McCain screws it up (like his retarded joke of "Bomb Bomb Iran" gig).  Ignore the polls at this point.  Don't underestimate racism, which I sadly submit will impact the results.

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