Both Exelon (EXC) and First Energy (FE) took major hits on May 28th due to two related events. First was a power auction conducted by PJM Interconnection LLC on Friday, which is the transmission supplier for 60 million people, mostly in the Mid Atlantic. Another was Exelon's downgrade by Deutsche Bank from Buy to Hold and a downgrade by Credit Suisse to First Energy from Outperform to Neutral, both based on an oversupplied power market. Let's dive into these power auctions from PJM.
PJM just completed its auction for the year starting on June 2016, and it needs to acquire adequate supply. New power plant supply increased by 5,463 MW, a record amount, beating the record amount of last year of 5,346 MW. With the extra power available, PJM paid reduced prices to generators for its available megawatts.
In the current generation year, which ends in just a couple of days, generators are only getting paid just over $16 per megawatt day for their capacity. Starting June 1st, this price will nearly double to $28 per megawatt day. Looking ahead at the 2015-2016 year, generators are getting paid $136 per megawatt day, which is nearly a 500% increase from the payments starting June 1st. The "bad news" came last Friday from the auction for the 2016-2017 year, as the price drops to $59.37 per megawatt day, over a 50% reduction. Below is a table that shows auction results for the past many years, showing past results, and past auctions, up to the recent auction for 2016-2017. Numbers are rounded to the nearest full dollar. These values are from a report from PJM.
Resource Clearing Price
Cleared UCAP (MW) x1000
Reserve Margin %
The auction is a base residual auction, which is generation available to the grid, 24/7/365. This payout is what would be considered a capacity charge for the grid. The utilities will still sell their generation to customers by the megawatt hour, (MWh). Below I will list the megawatts available for each utility, then use 85% of the megawatt days (average that cleared UCAP) for the payouts for each company.
First Energy states that it produces about 23,000 megawatts of generation, which would be about 8.395 million megawatt days maximum to sell to PJM.
Exelon states that it produces about 35,000 megawatts of generation, which would be about 12.775 million megawatt days.
PPL Corporation (PPL) has about 11,000 megawatts of competitive generation, which would be about 4.015 million megawatt days.
Below in my chart, I am going to illustrate what this money means per share for these companies, of course this is gross earnings, not net.
Shares Outstanding (millions)
2013 Contribution ($/share)
2014 Contribution ($/share)
2015 Contribution ($/share)
2016 Contribution ($/share)
2017 Contribution ($/share)
So why did I spend the time to illustrate this? Because these companies are actually going to have increased earnings from generation over the next 4 years, before a decrease, which is still almost 4 times more than they are getting paid this year.
Next year should be a good test for these utilities, to see if their generation is profitable. Of course, as I stated above, this is just a capacity income for the generation for these utilities; they will still make money off of the sales of generation. Historically, the capacity payment was somewhere between 10-20% the total cost of generation for the customer, or about 25-30% of the profit for baseload generators.
There is great concern that generation prices may continue to decrease with a continued weak economy, low natural gas prices and energy efficiency initiatives; however, I personally believe we are at a floor for generation prices. The economy appears to be slowly improving, the price of natural gas is up over $4 per MMbtu and some older generation is coming offline between now and 2015. With any additional increase in natural gas costs, whether we are ready to export by 2016/2017, other plants being retired and upgraded transmission lines, the prices should become more steady and competitive. The power auction is a big hit in June 2016, from June 2015, but it's a big price improvement from today. That is what needs to be highlighted. If the news said that base residual auction prices are over 300% higher than current year, these stocks would have gone up, and not down.
With First Energy falling about 8% so far this week, and paying over a 5% yield, now is the time to buy First Energy, and time to also think about buying into EXC and PPL.
Additional disclosure: I may purchase EXC as well within the next 72 hours. I work for PPL, but have not provided any non public information.