Texas Needs Electricity, These Companies Can Help

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For the second year running, Texas is short of electric capacity for projected peak demand periods, according to The U.S. Energy Information Administration (EIP). While that's clearly bad for Texans trying to beat the heat, it means there's pent up demand for companies like Calpine (NYSE: CPN), American Electric Power (NYSE: AEP), and CenterPoint Energy (NYSE: CNP) to fill.

Hitting the Peaks

Electricity demand is highly variable because weather helps dictate customer usage. There are really two issues for utilities, the ability to reliably meet base demand and the ability to handle the inevitable spikes in demand from extreme weather conditions.

Texas isn't as prepared as it should be for the peaks. That's a big problem in a state that is both very hot and growing. The state's sun belt geography is a fairly obvious issue. However, it was also the first to rebound during the recession. Not surprisingly, the state has some of the fastest growing cities in the country.

A Double Whammy

Having a booming economy is a good thing, but it means more electric use. That's a problem in Texas, where regulatory relationships have historically been less favorable than in other regions. For example, Texas has “the only regional transmission organization (RTO) that does not have a mechanism for paying for reserve supply,” according to EIP. Usually these costs are covered through retail electricity rates.

So, there's little incentive for utilities to build out the needed peak capacity. That said, things may be changing for the better. For example, CenterPoint Energy, which derived about 40% of its top line from Texas operations in 2012, was allowed a return on equity in line with the national average in 2011. It was also allowed to file for annual reviews. If this improving environment continues, utilities should start to build again.

A Wired Company

American Electric Power, or AEP, is one of the largest domestic power companies. It has operations in 11 states and serves over 5 million customers. The company's Western division encompasses operations in four states, and Texas is heavily represented. The operation there is focused on transmission assets.

Mario Gabelli recently noted that the company's AEP Transco division, which handles transmission, is likely to spend $2.5 billion on new projects. The country's aging infrastructure has also led to favorable regulatory treatment of such spending. Gabelli is modeling this division to contribute $0.31 a share to earnings by 2015, up from $0.06 in 2011. Since Texas is a growing market with increasing demand, it will be a driving force behind the division.

The company's dividend was trimmed in 2004, but has grown regularly, though not annually, since. The company's top and bottom lines bounce around a little bit because of commodity costs, however it is well positioned for the future and offers an around 4.4% yield.

Free Agent

Calpine is among the country's largest independent power producers. The company's Texas division represents about 30% of its total generating capacity. That puts it in prime position to benefit from one of the strongest states in the country, particularly as regulators begin to soften their stance on rate cases. In fact, a relatively low cost operator, Calpine power plants should be among the first tapped by utilities to help handle demand increases.

The company took a trip through bankruptcy after the Enron scandal pummeled the merchant power market. However, public again, it has a young and efficient power fleet. Earnings and revenues have been volatile of late but haven't had much of an impact on the company's shares. Solid positions in key markets like Texas and California, where nuclear plant closures are likely to spur demand for Calpine's gas fired plants, makes it a solid growth-focused opportunity.

In State and More

CenterPoint Energy has a large power business in Texas, but also owns mid-stream energy and gas distribution assets, among others, and ultimately serves around five million customers across five states. That said, growth in key Texas markets like Houston will be a long-term benefit to CenterPoint's top and bottom lines.

The really interesting aspect about the company, however, is its plan to spin off its mid-stream assets in a limited partnership (LP). Although the move will take a few years to start benefiting CenterPoint, it allows the company to monetize assets and still benefit from the cash flow they produce. This corporate shift will likely leave the shares trading more on news than performance in the near term. However, with an around 3.6% yield backed by seven consecutive annual dividend hikes, a key position in the growing Texas market, and the potential of the LP move, special situation investors might want to take a look.

Everything is Bigger in Texas

Electric capacity not keeping up with demand is something that can only go on for just so long before something gives. Since customers don't like rolling blackouts, it's likely that utilities will find a way to satisfy demand. And Texas regulators increasingly look willing to help. That should put companies like Calpine, AEP, and CenterPoint in a good position to benefit.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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