Power Auction May Foreshadow Rise in Utility Bills, Energy Stocks

Price increase could add about $2 to $3 to average consumers’ monthly bill across territory.

Source: Wall Street Journal

By: Timothy Puko

The price of power that the U.S.’s largest grid operator pays utility companies for power rose across the board at an auction Friday, with prices nearly doubling in New Jersey and Philadelphia, foreshadowing a potential increase in electricity bills and a rise in the share prices of some power companies.

The price increase stems from a series of reforms that grid operator PJM Interconnection LLC enacted after widespread failures led to brownouts during the frigid winter of 2014.

The price rise could add about $2 to $3 to the average consumers’ monthly bill across its territory, stretching from Newark, N.J., to Chicago and supplying 61 million people.

PJM estimates that an extra $3.4 billion will go to the system’s power companies in exchange for a guarantee that starting in 2018 they will run when demand is highest, a safeguard put in place after the 2014 failures.

Several investors and analysts say the auction results are likely to boost share prices of power companies with plants that supply the PJM market. The companies most likely to benefit include NRG Energy Inc., Exelon Corp.,Calpine Corp., Dynegy Inc. and Public Service Enterprise Group, analysts said.

“Everything investors generally hoped for happened,” said Douglas Simmons, a fund manager at Fidelity Investments.

The so-called “capacity price” was set at $164.77 a day for every megawatt produced by power plants across most of PJM’s territory from July 2018 to May 2019, according to results of the annual auction PJM released after markets closed Friday. That compares with $120 a megawatt-day established last year for nearly all of the territory, regions that include some Washington, D.C., suburbs, Pittsburgh and Chicago.

Prices in the Chicago region and parts of the East Coast will go up even more, with a strip from New Jersey to Virginia seeing prices hit $225.42 a megawatt-day, up 88% for most of that area.

The award largely matched analysts’ expectations, which had generally ranged from $150 to $200 a megawatt-day. Moody’s Corp. had called this “arguably the most important” PJM auction in their eight-year history both for PJM’s plan to improve reliability and as an earnings driver to help companies.

At the auction, power producers bid for long-term contracts to supply electricity. Other businesses, including big consumers, offer to pay for improvements in efficiency or even to cut grid power. PJM chooses the best values and guarantees the winners get paid starting in 2018 even if demand drops.

PJM runs the largest capacity market in the country. There are critics who say it amounts to market manipulation and some regions, notably Texas, refuse to adopt them, saying free markets alone will encourage the construction of enough power supply.

Advocates of capacity markets, including PJM, say it is a market-based system that emphasizes and ensures reliable power.

All power bills within PJM’s 13 states include the capacity price, which accounts for about 10% to 15% of their charges to consumers, experts say. Spot and near-term prices for electricity, and the administrative costs for running the system, make up the rest of electricity bills.

Power producers rely on these payments as baseline revenue, and share prices often jump sharply in response. When the auction two years ago awarded sharply lower prices, utility stocks fell at the start the next trading session. Last year’s auction brought prices that rose even more than this year, and several utility company stocks started the next trading session as the hottest in the S&P 500.

Electricity commodity prices have fallen by about a third in the PJM market this summer, another factor that added to the capacity payout, said Swami Venkataraman, an analyst at Moody’s Investors Service. The auction results showed power companies were bidding up prices because they needed to bolster revenue for running plants, regardless of the new demands PJM issued, he said.

“People are bidding higher because the energy markets are not giving them the revenues that they need,” he added.

Stagnant demand, falling natural-gas prices and tightening environmental regulations have put power companies in a crunch in recent years. Gas fuels power plants, and when prices rise, utilities can raise their prices on top of that, then spend the added revenue on capital projects and dividends. But gas prices have been falling, taking power prices down along with them. It is limiting the cash companies have just as consumer demand has flattened and a generation of old and dirty plants need expensive improvements and replacements.

Yield-seeking investors did flock into utilities in 2014 because of their high dividends. But they have retreated this year as the Federal Reserve gets closer to raising interest rates, making government bonds more attractive. S&P 500 electric utilities are down 6.3% as a group year to date, while the broader S&P 500 index is down just 4.3%.