EIX Sticks with Coal

“The Electric power business has the potential to change more in the next 10 years than it did over the last 100 years.”[1]

That was the unsurprising statement in the Southern California Edison (EIX) second quarter conference call for investors.  The slide presentation provides an interesting snapshot of SCE’s view of the current markets and regulatory environment.

EIX missed its earnings target for 2Q but tried to put a good news spin on its overall market story. About 88% of EIX earnings come from its regulated California utility business, Southern California Edison.

EIX is a solid company with well earned green credentials from its substantial investments in renewable energy in the quest to meet California’s aggressive 33% RPS targets.  No California utility is on track to make those goals and SCE is no exception so it is doubling down with approval for 250MW of additional renewable energy procurements and a like amount of utility-owned renewable project construction to keep its regulatory bosses at the California Public Utilities commission (CPUC) happy.

EIX’s PE ratio of 9.4x (TTM) is low compared to 15.1x average for Electric Utilities. With one year EPS grow of -29.30% investors have been in no mood to pay a premium for EIX’s growth potential since the average electric utility earning were off by only -8.61% for the same period.

Post Waxman-Markey Strategy Bet on Coal

Despite the growth in its renewables portfolio, EIX has hedged its bets on the unregulated side of its business in the Edison Mission Group with a large position in coal.  Along with the earnings call, EIX announced it was planning to spend $1.2 billion to add scrubbers and other improvements to its coal plants.[2] EMG’s Midwest Generation Unit primarily uses Powder River Basin coal but its adding new scrubbing equipment because it must cut SO2, mercury and particulates at its Illinois plants.  EMG also operates the Homer City plant strategically placed in the PJM power market but it uses Northern Appalachian (NAPP) coal.

In the build up to an expected climate change bill passage by Congress, many analysts had virtually written off these older Midwest coal plants and expected their owners would junk them if the bill passed.  But stuff happens and the inability to get 60 votes for Waxman-Markey or any other climate change legislation this Congressional session is forcing many to rethink their strategies.

EIX has maintained all along that its EMG coal portfolio has plenty of residual value.  The $1.2 billion to retrofit these old Illinois cola plants is at the lower end of a range of improvement costs which could have approached $2.5 billion.  Nonetheless, there is plenty of life left in these plants and improvements both increase their efficiency, capacity factors and performance while reducing emissions is a prudent investment.

Putting Wholesale Power Markets to the Test

In 2005, while I was at Global Energy Decisions, we were engaged to do an independent study of the difference in performance of old power plants divested by utilities to determine whether operations at the plants improved in a competitive wholesale power market environment.  That study entitled “Putting Wholesale Power Markets to the Test” found that there was $15.1 billion in savings as a result of the new owners “fixing up the plants” to minimize fuel expenses, operations and maintenance (O&M) costs, depreciation and taxes in the study period.  The result was a 16 percent increase in coal-fueled power plant capacity factors from 1995-2004, which is enough energy to supply power to 25 million residential households.[3]

So what?

California’s energy markets are driven by the aspirations of its politicians and their regulators who are focused on the following policy goals:

  1. Reduce greenhouse gas emissions by implementing AB32
  2. Expand the use of renewable energy to 33% of electricity supplied to customers
  3. Make a home for PHEV cars and trucks to create a market for new technologies
  4. Implement smart grid to improve performance, efficiency and reliability
  5. Expand service options and assure reliability for customers and the State’s economic growth.

What is noticeably missing from the State’s goals is any serious mention of what all this will cost ratepayers or the competitive positioning costs to the State as a place to do business.  It’s not an afterthought—in many cases cost to ratepayers has been a consequence not the primary concern of California policy makers.  Utilities like SCE must bear the brunt of these cost increases and thus must raise rates at a time when the economy is weak and California is struggling to regain some competitive advantage to bring back growth and jobs.

In the Midwest it is a must different story.  Costs matter and low cost power generation is the one competitive advantage the Rust Belt still has going for it.  Keeping that low cost generation in service, making it perform better and reducing its environmental impacts is a good thing.

EIX and Sempra have chosen strategies to expand their corporate business footprint beyond the regulated utility business in the Golden State.  PG&E has bet the farm on California alone.  The Golden State policy priorities put all three companies at the front lines of change over the next ten years whether they like it or not. Elections matter and 2010 and 2012 matter A LOT for electric utility policies and ratepayer costs in California and elsewhere.

EIX may have missed its 2Q earnings targets and be taking heat for investing in cleanup its old coal plants to eek a few more years service out of them—but it may prove to be a far less risky strategy than relying on emissions reduction, renewable energy, smart grid and PHEV as the growth savior for the next ten years.

In almost any scenario, America will eventually pull out of the recession and is expected to return to historic average electric load growth of 1-2% per year.  When that happens, EIX may be far better positioned with its “fixed up” coal portfolio than others who bet the farm on higher cost renewable energy that needs to be backed up MW for MW with fossil fuel to be reliable.

It would be ironic if the EIX investment in upgrading its old coal plants in the Midwest had a more profound impact on achieving environmental goals at lower costs than its investment in more expensive renewable energy projects in California.  I doubt that California politicians and regulators will want to spring for that study of wholesale power competition at work.

[1] SCE 2Q Earnings PSN for Investors: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MzkyMjY0fENoaWxkSUQ9Mzk2NzI1fFR5cGU9MQ==&t=1

[2] Coal Plant Clean Up Costs: http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201008051420dowjonesdjonline000650&title=update-edison-international-estimates-12-billion-plant-cleanup-cost

[3] http://www.epsa.org/forms/documents/DocumentFormPublic/view?id=48160000000E