Saving Grace: A Nice Boost for Natural Gas Prices
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
August 2011 to July 2012 was the hottest 12-month period the U.S. has seen since 1895. Of course Americans love warmer winters and sunnier summers, but non-tepid temperatures have implications that reach far past vacationers looking for an attractive bronze tan.
For example, 30 states were plagued with draught, causing agriculture commodities like corn to skyrocket. The heat also has major implications for firms who produce electricity.
Power plants suck up half of all water taken from U.S. fresh water sources, a staggering 200 million gallons per day. Firms’ nuclear, coal, and gas units convert this water to steam, which turns their turbines. The resulting energy cools their equipment, hot from producing electricity. After use, the water is seldom reused. Instead it is returned to the lakes or rivers, sometimes 20 to 30 degrees hotter. The water shortage during the past year, coupled with higher temperatures, have electricity companies searching for alternatives.
Power Companies Need a Change
Chicago-based Exelon (NYSE: EXC), a retail electricity distributor, has its Braidenwood nuclear power plant in Illinois. Low water and high temperatures have the company looking for other solutions than running tremendous water volume through its plant each day. Exelon faced trouble when its cooling pond reached an incredible 102 degrees Fahrenheit, forcing it to obtain permission of the Nuclear Regulatory Commission to continue operations.
To continue stable production, Exelon must figure out a way to keep water temperatures low, or to switch away from water to another energy source. (As an aside for dividend investors, Exelon is a nice income play, with a 5.9% payout and a 15.3 P/E ratio.)
Like Exelon, Dominion Resources (NYSE: D) struggled with hot temperatures. When the Long Island Sound reached temperatures of 75 degrees Fahrenheit, Dominion’s Connecticut-based Millstone plant closed one of its two reactors. The cessation lasted for an entire two weeks, costing the company 255,000 megawatt hours, a multi-million dollar shutdown.
To continue producing electricity, Dominion must either persuade regulators that the higher temperatures will not affect local ecosystems or it must also find a substitute for its inefficient coal-fired plant.
How can Exelon and Dominion trim their use of seawater and fresh water? Electricity generator AES Corp. (NYSE: AES) may have found an answer: scrapping plants powered by coal in favor of plants powered by natural gas.
AES plans to experiment by building gas-powered units at its Huntington Beach, California site. The plan is to build a $30 million air condenser, which would pressurize the natural gas so that it would take up less space, allowing more to travel through a pipeline or to be stored.
AES hopes the change will trim the 270 million gallons of seawater and 260,000 gallons of freshwater that it uses each day to just 41,000 gallons of freshwater. However, its natural gas use will boom, giving two companies an opportunity to capitalize.
Capturing the New Demand
The hot temperatures have shown electricity generators how dependent they are on water, and a move to natural gas would be a major boost to the major natural gas producers.
Many drilling firms in the U.S. are now shirking natural gas in favor of more profitable oil drilling, but eventually natural gas prices will rise. Exxon has been holding its natural gas assets while other firms have been unloading theirs at depressed prices. With its enormous size – a market cap that tops $425 billion – Exxon is ideally situated to quickly ramp up natural gas drilling. Moreover, the firm pulled in $55.1 billion in operating cash flow, money that can be quickly shifted to invest in capital expenditures that fund natural gas operations.
Like Exxon, Chesapeake will also profit from a price increase because it holds rich natural gas assets. Even though it has been selling natural gas assets to fund its oil drilling operations, the company is still holding small stakes in the assets it sold, like the company’s rich Permian Basin in Texas.
If natural gas prices move upward, the key for Chesapeake will be moving cash to its assets that will produce the highest returns. Right now, with $1 billion cash, $14.6 billion debt, and just $4.8 billion in operating cash flow, Chesapeake is not poised to make such a fast move. However, if such a price increase comes, I have no doubt that Chesapeake’s financial engineering CEO Aubrey McClendon and major shareholder Carl Icahn will find a way to make the switch.
By trimming coal plants, which rely on water, and switching to natural gas-powered plants, electricity producers will demand a major amount of natural gas, a positive for the ailing commodity. The price boost will be a huge plus for the companies who can see the price jump coming, and who can supply the producers with natural gas to fund their operations.
While water has powered plant turbines faithfully for many years, natural gas is an exciting innovation – one that will hedge the electricity producers from another potentially scorching year. And the vacationers can still enjoy their hot weather and nice tans.
ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Motley Fool newsletter services recommend Dominion Resources and Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.