We at The Motley Fool do not get too worked up over short-term stock movements, but sometimes they can forewarn investors about larger, fundamental problems. For example, Exelon (EXC +0.64%) stock was trekking upward in late April and appeared to be threatening the 52-week high set last summer. I guess it just wasn't meant to be. Shares quickly slid to open the month of May and dropped precipitously at the end of the month. What's going on with this fluctuation? Should long-term investors be grabbing their hardhats or their checkbooks?
When long term is silly
The reason for the late-May Exelon stock massacre had nothing to do with short-term problems. Instead, PJM Interconnection -- the gatekeeper of the Midwest regional grid -- announced the final bidding results from an auction dishing out capacity at power plants for the year beginning June 1, 2016. The auction closed with Chicago power fetching just $59.37 per megawatt-day. As Steve Daniels of Crain's Chicago Business explained: "[That's] about half of what analysts were forecasting and less than half of the $136 per megawatt-day set in a previously held auction for 2015-16. For Exelon, that means capacity revenue will fall about 41 percent in the year beginning June 1, 2016, to $847 million from about $1.4 billion the previous year."
That's because most of the company's industry-leading nuclear capacity feeds the Chicago grid. Furthermore, as regional energy prices are pushed lower by cheap wind power, selling future capacity at auctions has become an increasingly important revenue source for Exelon. The production tax credit, or PTC, has pushed energy prices to artificially low levels in the country's breezy heartland. At certain times of day during the year prices even turn negative -- meaning Exelon and others actually pay customers to take the power they create.
Competing energy generator NextEra (NEE +1.87%) has made a killing on the PTC with its industry-leading renewable portfolio, albeit at the expense of Exelon. Fully 57% of the company's capacity comes from wind farms, while 55% of Exelon's portfolio is comprised of nuclear. Simply put, Exelon is at a slight disadvantage for this energy mark. Just don't get too worked up over short-term trends.
One thing PJM Interconnection forgot
Interestingly, the PTC wasn't the major reason for the low auction prices, according to PJM. The company maintains that swelling natural gas capacity was the driving force behind the auction prices. Funny thing about that: natural gas prices from 2012, which many projections are (sadly) based upon, were an absolute anomaly.
Yes, natural gas is displacing coal in the market, but I think its rise is a little exaggerated. The near doubling in natural gas prices forced many coal-fired power plants to resume operations last winter. That is good news for Duke Energy (DUK +0.52%) and Southern Company (SO +1.42%), which use coal for 46% and 38% of their generation portfolios, respectively. They, too, are suffering from low auction prices in natural-gas-heavy regions, but rising natural gas prices are good news for their futures. It is a little less obvious, but that is also good news for Exelon. Should natural gas prices remain higher in 2016 -- which seems pretty likely -- I don't think energy generators are going to sell their power at less than competitive prices. If PJM can adjust these prices upward in the future, then I fully expect that to happen.
Foolish bottom line
The downward pressure from the PTC will continue to weigh on margins for Exelon, but don't expect it to last forever. Similarly, I do not see natural gas keeping Chicago power prices at 50% of historical prices. If I am wrong and this trend is the new normal, then Exelon will need to ditch some of its nuclear fleet (easier said than done) to become more competitive. However, I don't think that the company's nuclear-heavy portfolio is a long-term liability -- quite the opposite really. All in all, I think Exelon is worth a look for long-term investors, especially at these prices.
