Tag Archives: Energy

A little love for the electric utilities

Energy, On the cover, Sin categoría

(published Thursday 22nd in Cotizalia)

What a bad two years of stock market behavior. The “utilities” sector (SX6E Index) is one of the worst performers in 2009 and also did not do well in 2008. Since the process of mergers and acquisitions was completed, the industry suffers the hangover of debt, falling demand, electricity prices stalling and, lest we forget, these European regulators that do so much damage to the investment process.From the UK to Belgium and Finland we read news of interventionism and regulatory decisions that make impossible the proper management of a business that has become more cyclical and capital intensive over the years. Here in the UK, the government has repeatedly threatened with windfall profit taxes. Perception of public service, it is called. But when the sectors of water or gas are drowned out by generating returns below their cost of capital, the only one who comes to the rescue is the market. As proof, three figures: €12bn euros in capital increases, €65bn in debt refinancing and €22bn in forced divestments due to the high debt in European utilities between 2008 and 2009.
In Spain it’s similar. It is almost impossible to manage long-term investments with fluctuations in something as essential as is the policy on nuclear power, delays in the collection of the tariff deficit, endless delays in regasification regulation and without a coherent policy and planning capacity. When the government is striving to manage the country’s reserve margin without the sector ends up having to give subsidies to coal generation.
But let’s look at the positives. For there are a lot. The sector is clearly oversold on technicals. Additionally, two recent reports from Merrill Lynch and Citigroup indicated that it is the most underweight sector in the portfolios of investors. It trades at a PE compared to the market of 0.8, the lowest level since October 2000 and gives an average dividend yield 5.5%. Moreover, debt is being corrected quickly with good divestitures.
In an industry that has seen a drop in earnings per share of only 10% on average during a period of recession, current multiples are not demanding. At a PE of 12x average, the lowest since 2005, investing in this sector is a low risk bet if investors anticipate the return of inflation and improving demand.

The market has done well to play the cyclical sectors anticipating a recovery, but, for example, the percentage of exploration and production (E&P) stocks that are trading at higher prices than those when oil was at $ 140/barrel is almost 100%. I still see value in the cyclical, but I get the feeling that it’s time to give a little love to the “utilities”.

Careful with German power prices

Energy, On the cover, Sin categoría,

Looking at the way German power prices have lagged other commodities over the past couple of weeks, German power looks to be heading into the low €50s/MWh… but NOT higher:

  • Gas prices have stalled and open cycled plants still meet peak demand needs inGermany; and
  • Coal looks solid given ongoing Chinese coal import data and current difficulties in exporting out of South Africa.

However, upside to the mid-€50s/MWh looks too much of a stretch:

  • French supply-demand balances are extremely tight but for transitory reasons;
  • South African coal export difficulties are related to the current expansion project which is said to be about to commission (some 4 months late).
  • Underlying clean dark spreads look high for the oversupplied power market we are currently experiencing.

So targeting a move to just €51-52/MWh makes sense (5-10% upside from 8th October) but not the 15-20% plus that there might be in some other commodities (from early 8th October).

Open cycle gas plants represent about one-fifth of the price setting merit order. Given the six month lag in contract prices, there could be about a €3-4/MWh rise in the contracted gas price (given the lag in the contracted price, it is easy to predict the German gas price going to €18-19/MWh in 3 months), which would equate to about €2/MWh onto the baseload power price. The gas purchase agreements that the German buyers have with Gazprom are under intense renegotiations currently (the buyers can’t take the volumes they’re contracted to take, let alone at the price they’re contracted at) which I expect to be resolved by reducing volumes whilst maintaining the oil price linkage.

Surging spot prices in France have helped German 2010 prices, but that may wane. Spot prices (within day) have hit several thousand euros per MWh in France as capacity failed to meet forecast levels this week. The week ahead French price is up 22% over the past ten days. This caused power prices to surge and has lifted the forward curve, so the French 2010 baseload contract is now over €6/MWh above the German equivalent. This level of premium is not unprecedented (especially for this shoulder period as demand builds seasonally and stations are slow to come back online from maintenance outages); however, a more usual level would be €2-3/MWh.

Clean dark spreads look a bit generous given the lack of capacity tightness in Germany. Clean dark spreads of around €20/MWh would be needed to justify new coal stations (if operators could get comfortable with the carbon risk) but no-one is racing to build so likely to see downside to the spread.

German power is in strong contango. This though can be explained by the contango in European coal. This does not make sense over the medium-term: (a) China will lift domestic thermal output so will no longer be a significant buyer on the seaborne markets, and (b) expansion plans in South Africa will mean exports rise by around 30mt annualized, and (c) renewables will take any medium-term load growth from fossil fuels. However, Chinese coal imports for September may not have fallen (last datapoint on third chart to be confirmed) and there’s no evidence that the export terminal problems out of South Africa have been resolved (the final chart shows how annualized exports out of South Africa have fallen, although the expansion project is lifting throughput capacity to 92mt). The combination of China importing at an annualized rate of 70-80mt (of thermal coal) and South Africa falling 20-30mt short of annualized supply, is likely to keep European coal prices high despite excessive inventory levels in the UK and Europe.

Statoilhydro: Worth a punt

Energy, On the cover, Sin categoría
What is the only commodity that has not been played as a recovery theme? Gas. I am bullish UK Gas winter 2010 as LNG supply dries off and diverts into Asia, and on coal-to-gas switch (those CCGTs will burn gas to 60% utilization)
Statoil is the master hand managing pipeline gas volumes into the UK. Look at NBP pipeline volumes. Statoil is carefully managing up to 40mcm every day… The ONLY UK gas recovery play that trades at 10xPE (15% discount to peers).
I like Statoil ahead of expected bullish Q3 previews (out in 1 week) and Q3 report (out 4 Nov.) And because it’s the only UK gas exposed name that manages the volumes for profit, not cash.
Company specifics set to be great on the parameters that give higher multiples: Q3 production growth (gas) +10%, EPS growth ahead and Reserve Replacement improving for 2009 (to be published in the Q4 report in February).
With gas bottomed down at $4/Mcf and the oil price at $75 and a P/E of 10-11x, the Statoil share should be NOK170-173.

Short Term Commodity Dynamics

Energy, On the cover, Sin categoría

Oil markets have seen several points on the supply side. Nothing major but Russian output edging up to 10mmbpd, while OPEC sailings are expected to remain very low at c22.59 mbpd, leaving them 1.77 mbpd (7.3%) below last year’s level. Oil should continue in its $65-75/bbl range, but I still believe that the break-out from this range will be on the upside as the steady recovery seen outside China lifts distillate demand and as non-OPEC supplies disappoint as the year progresses. These data points will obviously become apparent closer to the 4th quarter, so short term dynamics will likely be driven by inventories, which can continue to build as refinery utilization reaches 83% from current 84.5%.

On gas, two issues are paramount – how much gas the Russians will pipe into Europe just as Europe is supposed to be lined up for rising LNG supplies, and how sharply US domestic gas production will tail off. With Ukraine’s gas transport company taking further steps to shore up its balance sheet and with Russia saying it’ll start to buy Turkmen gas, the signs are that Gazprom is expecting its pipeline deliveries to be substantially boosted from low H1 levels. My analysis remains bearish – new LNG supplies will struggle to be absorbed without pushing prices down, with Q1 2010 prices below $5/mmbtu necessary to clear the market (15-20% down). This week should see the first significant reduction in the official data for monthly US gas production, but nevertheless it is hard to create a bull case in the face of rising LNG supplies destined for the US.