January Utility Review

by: Robert Howard, CFA

Utilities were the worst-performing sector in January.

Only two XLU components were down for the month.

Milder weather compared to 2018 led to lower power and natural gas prices.

Utility stocks went from the best December performer to the worst January performer to start the year. The Utilities Select Sector SPDR ETF (XLU) trailed the SPY by over 450bp, and it trailed its closest sector, the Health Care Select Sector SPDR ETF (XLV), by 133bp.

Exhibit 1

(Source: FactSet)

Interest rates didn’t help utilities that much during the month, as the rate on the 10-year US Treasury only fell 5bp in January.

Exhibit 2

(Source: FactSet)

Investors also seemed to be making a slight shift away from utilities, as the assets in XLU declined by over $300 million from December’s levels.

Exhibit 3

(Source: FactSet)

When you start to look a little deeper at the individual names in XLU, performance for utilities in general was actually better than you might expect. Only two utilities were down for the month: Dominion Resources (D) and the now-bankrupt PG&E Corporation (PCG).

Exhibit 4

(Source: FactSet)

Dominion suffered from more issues around permitting for the $7 billion+ Atlantic Coast Pipeline in January. The company still feels the project will get completed and that these permitting issues are just a delay. However, these issues do add risk and cost to getting the job done. (See more on these issues here.)

PCG’s difficulties have been discussed multiple times (see here and here, for example), and the declaration of bankruptcy led to very poor stock performance. PCG’s contribution to XLU’s performance was actually worse than the numbers in Exhibit 4 would indicate. The stock was taken out of the index in the middle of the month after the company’s pre-bankruptcy announcement, bringing the number of companies included in the fund down to 27. At that point, the stock had already lost over 70% of its value from the beginning of the month. Later in the month, PCG stock got a positive bump when it was determined the company's equipment didn’t start the Tubbs fire in 2017. However, that positive bump did not benefit XLU.

Exhibit 5

(Source: FactSet)

The outperformance of the big XLU winners during the month seemed to mostly be a bounceback from big declines at the end of December.

Exhibit 6

(Source: FactSet)

AES Corporation (AES) was the big winner for the month with a gain of over 13%, but January’s closing price of $16.39/share was only 2.8% above the $15.95 December peak. However, AES did have some positive news, announcing the opening of a new 28MW solar facility in Hawaii and contracts for two new additional facilities in Hawaii.

Southern Company (SO) had a 10.66% gain during January, but this was only 2.2% above the December high of $47.56/share. The company did have some positive news during January, as it completed the sale of its Gulf Power Company subsidiary to NextEra Energy. The sales proceeds were used in a tender offer reducing SO’s total debt, and it reduces the company's need for future equity. SO’s Georgia Power subsidiary also reached a stipulation agreement with the Georgia PSC Public Interest Advocacy Staff approving the $526 million spent on Vogtle units 3 & 4 in the first half of 2018.

PPL Corporation (PPL) had a 10.55% gain in January, but this was only 0.7% above the December high of $31.11/share. PPL benefitted from the strengthening of the British pound, which increased the value of the company’s UK operations.

Exhibit 7 shows XLU component performance from each company’s December high. When analyzed from this perspective, Centerpoint Energy (CNP) has been the recent top performer in the group. The big positive news for CNP during January was the completion of its merger with Vectren.

Exhibit 7

(Source: FactSet)

Wholesale Power Markets

The cold weather at the end of the month looked like it was going to cause a lot of action in the wholesale power markets. In the end, the cold spell was not a big deal, and it essentially was overwhelmed by early January’s warm weather. With the exception of California, January 2019 wholesale prices were lower than those of 2018 across the board.

Exhibit 8

(Source: S&P Global Market Intelligence)

This year’s cold hit a little further west than last year’s. With less population, this year’s cold had less impact on the markets.

Exhibit 9

Electricity consumption was lower across all the different ISOs during January.

Exhibit 10

(Source: S&P Global Market Intelligence)

There was some excitement in PJM at the end of the month as the cold weather approached. PJM was forecasting total load on January 31st to be 142,000MW, which was within striking distance of its record peak of 143,338MW set in 2015. (See here for forecast and top 10 PJM demand days.) Its peak load ended up coming in at about 139,000MW. The lower demand was attributed to a larger-than-expected number of people staying home due to the closure of schools and businesses around the region. Power prices in PJM East did get above $100/MWh for a number of hours on these last cold days, but it was nothing like the cold spell we experienced at the beginning of 2018, when we had multiple days of $100+/MWh prices.

Exhibit 11

(Source: S&P Global Market Intelligence)

A big benefit this year was that the cold had been preceded by so much warm weather earlier in the month, and the lack of stress meant all equipment was ready to operate when this year’s cold weather struck. In Exhibit 12, you can see that the load at the end of this January was higher than the peaks from 2018. However, in 2018 there were multiple days of demand above the 120,000MW level that gradually built stress up into the system, which was one of the reasons why 2018 prices were so much higher than 2019 prices.

Exhibit 12

(Source: S&P Global Market Intelligence)

Natural Gas Markets

At the beginning of January, natural gas prices continued the commodity’s downward slide. There was a slight rebound in the middle of the month, but then the downward trend continued.

Exhibit 13

(Source: FactSet)

Natural gas has struggled so far in 2019 as the year-over-year storage deficit continues to shrink. At the beginning of the month, natural gas inventories were only 450BCF lower than last year. By the end of January, that deficit had shrunk to 135BCF. Part of the reason for the narrowing deficit is that it has now been over a year since the record 359BCF natural gas draw in the first week of 2018, which gets that result out of the YoY comparison. The last week of January brought more disappointment for natural gas prices. The storage draw was 237BCF that week, but this was below Wall Street expectations and gas prices have continued to decline.

Exhibit 14

There were some interesting changes along the natural gas curve during the month. The March 2019 futures contract decreased as the market strengthened its belief that there will be no gas shortage this winter. However, the contracts for all remaining 2019 months increased during January. For all 2020 contracts there was again an increase, but this was very slight. The futures curve was basically unchanged for the next few years, and it remained substantially below the curve’s levels from a year ago.

Based on the shape of the curve, today the market seems to be pricing in some of the weather risks that could create a temporary gas shortage in the near term. Longer term, the market seems to be saying we’ve got plenty of natural gas, and it is trying to send a low price signal to dissuade extensive gas production.

Exhibit 15

(Source: FactSet)

Disclosure: I am/we are long PPL, PCG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.