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Southern Company (NYSE:SO) is a leading U.S. provider of clean, safe, reliable and affordable electricity. The company operates electric utilities in four states with the help of Alabama Power, Georgia Power, Gulf Power and Mississippi Power. The company currently serves 4.4 million customers with nearly 46000 megawatts of generating capacity. The electricity generation is attained from 33 hydroelectric, 32 fossil fuel, 3 nuclear and 13 combined cycle generation stations. In addition to these stations there are four solar facilities, one landfill gas facility and one biomass facility.

Recent Results

The company's third quarter earnings were negatively affected by lower electricity demand. The lower electricity demand caused a 3 cent decline in the per share earnings dropping it to $1.08 per share compared to $1.11 per share during the third quarter of the previous year. The lower demand for electricity is attributed to the mild weather conditions. The company's reported revenues of $5.04 billion also missed analysts' estimates of $5.4 billion.


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Southern Company not only lost operating Income but also net income estimates from nearly all of its subsidiary companies. Moreover, the company indicated that it could lower its long term earnings growth range of 4%- 6% due to poor investment opportunities.

The product demand of utility companies such as Southern Company remains flat with little seasonal fluctuations. Therefore, the company is shifting towards cost-effective methods of producing electricity. Methods such as oil and gas based production to nuclear and coal based production.

Shifting Towards Cost-Effective Production

The chart below represents the current energy breakdown of Southern Company. Notice that the company is currently obtaining 45% of its overall production from oil and gas sources which are considered the most expensive sources.


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Plant Vogtle Unit 3 & 4: Nuclear Energy is the Future

With the ongoing nuclear project of Plant Vogtle Reactor Units 3 and 4,the company is aiming to shift its energy breakdown from expensive oil and gas sources to less expensive nuclear power. The two nuclear units have a total generated capacity of 2200 MW.

The Nuclear Energy Institute observed that since 2001 nuclear power plants have achieved the lowest productions costs in comparison to coal, natural gas and oil sources. The institute further observed that fuel costs make up 30 percent of the overall production costs of nuclear power plants. In 2012, the average fuel cost at a nuclear power plant was 0.75 cents per kWh. In addition to the fuel costs non-fuel operation and management costs were averaged at 1.65 cents per kWh.

On the other hand, fuel costs for coal, natural gas and oil sources, accounts for almost 80 percent of the production costs.

During September 2013, the U.S. Department of Energy and Southern Company reached a deal to extend the loan guarantee offer of $8.33 billion until December 31, 2013. This is the fifth time that Southern Company requested an extension.

Risks Associated with the Project

The estimated cost at the time of project's announcement was $14 billion but it has now increased by $1.5 billion to $15billion. In addition to that, there is a huge risk that construction costs might increase further.

Since the project's inception, it has encountered substantial construction delays and cost increases which caused the company's credit rating to be downgraded by Moody's. On October 21 2013 the agency announced that the power plant's project has increased the business and operating risk of utilities companies.

Kemper IGCC: Innovated Coal Gasification

In addition to the nuclear project, Southern Company is in the middle of a huge investment program that involves building a low-carbon coal unit in Mississippi. The unit is project is called Kemper IGCC. The plant is designed to meet the threatening EPA standards with a new process known as coal gasification. Although other plants gasify coal, this will be the first to remove carbon dioxide, which will be sold separately. In the past the removed carbon dioxide was either burned or dumped.

The new technology will offer Southern Company a strategic advantage over its competitors. However, the company does not seem to be interested in initiating another plant within the domestic market. Instead the company is planning to sell similar plants in China where natural gas is more costly and coal abundant.

The innovative project will yield long term favorable results yet there are certain risks that can put pressure on the company's share price in the short term.

Risks Associated with the Project

The project's cost is 65 percent over budget and rising. The director of energy at the U.S. Department of Energy believes the project's soaring cost makes it one of the most expensive fossil fuel projects ever made. The rising costs will put direct pressure on the bottom line. Moreover, further delays in construction can also prevent the planned May opening of the plant.

Conclusion

The company's financial performance is being adversely affected by the increase in costs and delays in construction. While the galloping costs may slow down bottom-line growth in the next couple of quarters I believe that this will only be temporary.

Southern Company is building the most diversified energy portfolio in the country with a total investment of $20 billion. The utility giant enjoys some of the best regulation in the United States. Conversely, delays in the startup dates and increases in construction costs pose a threat to the company's future earnings potential. The company has announced it will revisit its 2014 earnings estimate and long-term growth prospects during the fourth quarter earnings call.

With the construction of nuclear units and the development of the innovative coal gasification plant, the long-term prospects of company are high. However, much is dependent upon the Q4 earnings conference in order to have a clear understanding of the future growth prospects.

Source: Southern Company - Are The Risks Greater Than The Return?