Power troubles in California create opportunities for investors. They have already exploited the oil and gas exploration angle, as well as utilities. There may be good long-term opportunity in FuelCell Energy, a manufacturer of fuel cell generators.
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California is in trouble. Wholesale electricity prices in the "deregulated" market have swerved north at an alarming rate. They have averaged $330 per megawatt hour (MWh) so far this month, 11 times higher than last year's prices. After California dropped its $250 per MWh cap earlier this month, the price went as high as $1,400. The cause of the rise is manifold. First and foremost, higher natural gas prices have driven up power production costs. Domestic production of natural gas should increase only about 0.5% in 2000 compared to 1999, primarily because low prices in 1998 and 1999 caused producers to reduce their exploration and development programs. The jump in prices since January has stimulated drilling, but that won't have an impact until spring. The wellhead price (before transmission and distribution charges) for gas has risen from $1.69 per million cubic feet (Mcf) in September 1998 to around $4.40 this month. High natural gas and oil prices have boosted the exploration and development stocks like Anadarko Petroleum (NYSE: APC) and El Paso Energy (NYSE: EPG), both up around 100% this year. The near-term outlook for these companies remains good, since prices are not likely to return to 1999's levels, in spite of increased production. Moreover, President-elect George W. Bush has a soft spot for oil and gas companies. Bush argued in his campaign for opening the Alaskan Wildlife Refuge to oil and gas exploration. The industry can count on this and other initiatives on its behalf from the new administration. The market has priced a lot of this information into those stocks already, however. These are cyclical stocks, and it may be too late to play the up side. The shortage is not the result of limited gas resources, but simply a slow reaction to market demand. Long term, exploration stocks will revert to their cycles. A second, significant factor in the California power crisis is the state's insufficient infrastructure. Power plants in the state are aging and decrepit. Fifty-five percent of California's power plants are more than 30 years old, and nearly 30% are currently shut down for maintenance. Nevertheless, there is no plan to replace old plants, nor is there a drive to increase capacity in general. The power industry has applied to build 25 new plants, which would boost the state's supply by 30%, but only seven have been approved in the last two years. The sticking point has been air pollution regulations. Power companies have profited in the short term from this problem. The stock prices of the six companies that bought power plants in California when the state deregulated its utilities have soared. Duke Energy (NYSE: DUK) and Reliant Energy (NYSE: REI) have experienced 75% boosts, while Dynegy (NYSE: DYN) has jumped 250%. The S&P Utilities Index is up about 50% over the last 12 months. Utilities are undergoing a lot of change, as the nation looks to deregulate. That plan may change in the short term, thanks to California's bad experience, but it will happen. That will provide the industry leaders with growth opportunities in a stable, profitable environment. They should provide long-term value, if not exceptional gains of this year's magnitude. On the other hand, now might not be the best time to enter these cyclicals. If you're looking for a long-term play with high potential, consider the case of FuelCell Energy (Nasdaq: FCEL). The Danbury, Connecticut company has designed a fuel cell stack / turbine hybrid that promises to increase generator efficiency from 35% for conventional gas-fired turbines to 73%. More importantly, the fuel cell produces energy without combustion, eliminating the air pollution issue. That will make it a popular choice in California. Its generators are small, ranging from 250 kilowatts to 3 megawatts (MW), potentially as high as 100 MW by 2004. That won't solve California's problems, where upwards of 3,000 MW are required per day. It will, however, allow private companies or communities to supply their own power, bypassing the state's controls and aging transmission infrastructure. FCE will have production capacity of 50 MW by October 2001. It has already signed a deal with Enron (NYSE: ENE) that calls for Enron to secure 55 MW worth of sales in the next two years. FCE has also lined up customers in Japan and Europe, as well as PPL Corporation (NYSE: PPL) in the U.S. The problem will not be demand, but supply. FCE says the first 50 MW of manufacturing capacity will be the tough part. It anticipates ramping up to 1,800 MW by 2008, and projects profitability in 2005. California's problem is not going away. Demand for power continues to escalate, while air pollution concerns become more and more pressing. While oil & gas or utility plays may prove effective, they have appreciated a lot recently and are more easily subject to regulatory problems. Local, dependable, clean power generation will only become more attractive in the U.S., not to mention Japan and Europe. FCE may have the key to that future.
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