Looking for Energy in All the Wrong Places

In the end, consumers will pay the price. Depending on the state, they may see spikes in their gas and electric bills on the next billing cycle. Others may see high prices blended in on a state-mandated rate increase. No matter how, consumers will pay the price.

Before becoming angry, customers should realize their utility might not be profiting from high energy prices. Massachusetts, Rhode Island, New York, New Jersey, Maryland, Virginia, North Carolina, Georgia, Tennessee, Arkansas, Michigan, Indiana, Illinois, Wisconsin, Minnesota, Wyoming, Utah, Arizona, Nevada, Washington, Oregon and California decoupled their gas utilities.

Three additional states, Connecticut, Delaware and Nebraska are in the process of decoupling.

This means the utilities’ profits are disassociated from their sales of energy. This includes gas subsidiaries of Northeast Utilities (NU), Consolidated Edison (ED), Public Service Enterprise Group (PEG), New Jersey Resources (NJR), South Jersey Industries (SJI), WGL Holdings (WGL) and other local distribution gas companies.

Investors should not be running to these utilities for quick profits. They do well with or without high energy prices. That is because a general rule all states follow is that local distribution utilities are cost-plus businesses. They are entitled to pass prudent costs onto consumers. The difference is how those costs are passed. Some states average them over a year. Some average costs over a month. Others pass them on immediately. No matter how it is done, decoupled utilities theoretically do not profit on energy sales.

There are companies that do profit on higher gas prices. The big winners are owners of wind power, solar nuclear and coal power plants. No matter what the price may be for natural gas, their production costs remain stable. They book market-clearing prices set by gas generators. When natural gas prices are elevated, it sets the price for all generators, even if those generators do not use natural gas as fuel. Their gross margins are the difference between the market-clearing price and their production costs.

This is good news for Exelon’s (EXC) nuclear fleet. It is also good news for Entergy (ETR), NRG Energy (NRG) and Dominion Resources. At long last, their nuclear and coal units are earning decent margins.

This may not be good news for Calpine (CPN). Since natural gas sets the market-clearing price, their gross margin is the spark spread. The spark spread is the price difference between electricity and gas, which varies geographically and with time. Calpine’s efficient units will have decent spreads, but their less efficient units could earn small to zero margins.

North America has plenty of energy. Most of it is located in the wrong places. Local prices are at the mercy of the nation’s infrastructure. When demand is light, weak infrastructure gets by. When demand is heavy, local prices soar.

At the time of publication the author held no position in the stocks mentioned.