Corporate Advisory Insight: Rising Fuel Costs

Richard Pontillo from Thomson Reuters' Corporate Advisory Services group discusses the impact of rising fuel costs and alternative energy. Transcript: Hi, I'm Rich Pontillo, with this week's insight on the current state of energy price speculation and what it means for utility companies to continue developing renewable portfolios. Despite numerous bipartisan efforts to moderate energy costs here in America, electricity generation costs have skyrocketed in recent years as utility companies are forced to comply with tightening carbon emission standards. Traditionally, coal has been the preferred fossil fuel as its vast availability throughout various regions of the United States has kept pricing reasonable. To date, coal-fired generation equates for roughly half of the gigawatt-hours produced domestically while natural gas generation produces an additional 25% of output. This leaves less than a quarter of our electricity to come from renewable energy sources such as nuclear, wind, hydro and solar energy. According to U.S. officials at the EPA, since 1990, the U.S. electric power industry has cut sulfur dioxide emissions over 40% and nitrogen oxide by 3 million tons, while electricity demand grew nearly 80%. These statistics are directly correlated to the capital allocated for carbon reduction projects and the expansion of natural gas turbines. However, near record highs on natural gas pricing has created a conundrum for even the most savvy hedging strategy as power producers struggle to find cost efficient fueling. Typically, in times of high natural gas prices, electric generation producers have had the capacity to switch between fuels. For instance, when natural gas prices are extremely high, electric generators may switch from using natural gas to using cheaper coal or even fuel oil. This fuel switching has typically led to a decrease in natural gas pricing. However, with reserves fleeting into the summer cooling season and trader's speculating toward production disruptions due to hurricane related events, electric companies are not able to provide peak power without passing along considerable costs to the consumer. As a result, focus on renewable energy possibilities are greater than ever. As expected, simply "turning the switch" to alternative projects does not come without costs. Higher construction costs, radioactive waste disposition and lack of ideal environments for wind turbines have left utilities with few options and has kept existing carbon emission heavy coal plants and pricey natural gas peaking facilities in play. (Pause) Despite the Nuclear Regulatory Commission receiving over 15 submissions for new reactors in eight states, it's been 30 years since the NRC has issued a license to build a commercial nuclear reactor. And on the wind power front, it is expected that only 1% of our nation's power will come from wind farms in 2008 while solar power equates for even less. Lastly, despite short positions building in natural gas futures as traders are taking advantage of recent price strengths, it is not unreasonable to think we are only one disruption away from a sizable squeeze that could most certainly push the price over $15 per BTU, leaving utilities scrambling to pass along more costs to the consumer. From an investor standpoint, allowable pass through cost certainly favors the independent power producer. Select companies such as Reliant Energy, Mirant, NRG, Dynegy and Calpine depend on the price curves to sell electricity to local distributors at peak pricing. Their ability to benefit from heat rates, or the difference between cost paid for fuel translated into the price of electricity sold, has them outpacing the rest of the sector in terms of share appreciation. Considering most Americans are already feeling the pressure at the pumps, don't expect your local utility to moderate electricity prices anytime soon. I'm Rich Pontillo and this is Corporate Advisory Insight.

YouTube | July 1, 2008

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