Ms. Storozynski: The Midwest economy and thus power demand are particularly weak, which together with low coal and natural gas prices has depressed power prices in the region. Margins of independent power producers (IPP) with power plants in the Midwest are feeling the pressure. The impact is partly offset by power and natural gas hedges, though the timing and the effectiveness of these hedges is key. Dynegy (DYN), with a large portfolio of coal-fired power plants in Illinois, is experiencing a sharp compression of margins despite a high level of hedges. The weak margins of coal-fired merchant power plants are not limited to the Midwest, however. As natural prices have fallen below US3/MMBtu, we are observing a coal-to-gas switching, and thus a temporary displacement of mid- merit coal-fired plants with gas-fired units. IPPs such as RRI Energy (RRI), with coal plants in Pennsylvania and Ohio, are seeing dismal earnings due to pressure from weaker production volumes and pricing. RRI has little to no short- term power hedges to offset the impact. The impact on near-term earnings of other IPPs, such as NRG Energy (NRG), Calpine (CPN) or Mirant (MIR) is negligible because their power output is highly hedged at natural gas prices above US7/MMBtu on average.
TWST: So it really depends upon business decisions that were made on the fuel
side rather than conditions in the economy?
Ms. Storozynski: Power prices are more sensitive to natural gas/coal prices than
to the power supply-demand balance, reflected through market heat rates. Given
that most of IPPs are highly leveraged, they cannot afford to stay open, because
in commodity price environments like the current one, they would not have been
able to service their debt. And so they tend to sell a portion of their future
power output forward under long-term power contracts, or they try to fix power
prices for their projected production using financial instruments. This strategy
caps potential earnings of IPPs if commodity/power prices rebound, but during
the times like now, give IPPs a safety net. Some of the IPPs are more skillful,
or lucky, than others in timing their hedges, which in turn impacts their near
term earnings. Investors tend to appreciate the hedges in the down commodity
cycles, but then again oppose them when commodities are rising. The problem is
it is rather hard to anticipate when the cycle swings.
Tickers included in this excerpt: CPN, DYN, ETR, EXC, NRO, RRI
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