Mr. Judge: Currently there are quite a few things that people are focusing on. Some of them are near term and some of them are further out. A current theme is a concern that treasury yields are potentially going to rise meaningfully and what headwind does that pose to high-yielding utility stocks. Historically, utilities have underperformed and actually declined as 10-year treasuries rise. There have also been questions about the potential lapse of the preferential dividend tax rate.
Another major topic relates to electricity prices, which are very low. If you look at forward curves, they indicate that power pricing will be very low for a very long period of time. There are a lot of questions and drivers around that, but more or less investors see continued low power prices and therefore the growth in earnings and cash flows for many of the deregulated utilities, or vertically integrated utilities, appears to be uninspiring.
TWST: What's the issue here? Is it that the economy is poor and therefore demand is poor?
Mr. Judge: What appears to be weighing on future power pricing currently is the economy and the record level of decline in demand, especially in the industrial manufacturing sector, from the middle of 2008 through 2009. It was also compounded by the fact that we had a very cool summer in 2009 with very little hot weather, which also depressed demand.
There are other factors to take into consideration, including low fuel prices, which typically are natural gas and coal. We have had a high level of coal inventories and generally, alongside of other commodity prices, coal has pulled back quite significantly from the peak in 2008. This causes electricity to be cheaper to produce. Then with regards to natural gas, it has also seen a pretty significant decline in strip pricing for the next several years, partly due to the fact that inventories were building from fairly solid production levels, lower demand due to the economy, and the evolution and development of shale gas. There is a very prevalent concern in the market today that there is going to be a significant amount of very productive shale gas plays out there, which will flood natural gas markets and cause natural gas prices to be depressed for some period of time. Natural gas prices are an important factor in establishing the price of electricity. If natural gas prices are low, then it would make sense that electricity prices would also remain low.
Tickers included in this excerpt: AEP, CEG, EXC, PEG, PGN
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