Tag Archives: california

Public Utility Commission Decisions Will Determine The Future Of Investor Owned Utilities

Investors in utilities should be considering the impact of alternate energy sources on utilities. One of the best way to measure the impact is by looking at the decisions of the Public Utility Commissions and how they respond to alternate energy sources. We look at California market as one example where the Public Utility Commission decisions should discourage utility investments. When electricity rates go up in a region, consumers in that region are quick to blame the local utilities and cast them as villains. This phenomenon is particularly acute when it comes to Investor Owned Utilities. While the IOUs profit motive gets most of the blame, in many regions of the US, utilities operate under some very specific mandates from local Public Utility Commissions. This dynamic did not matter much to utility investors in the past since utilities were in a monopolistic situation and customers did not have much of a choice when it comes to energy sources. However, times are changing and in this era of distributed energy, utility investors should factor in the mindset of the relevant PUCs in determining which utility investments are vulnerable. The concern about utility future is especially acute in states where solar penetration is increasing rapidly. In these states, a local PUC’s response to solar and wind technologies is one very good way to assess whether a utility can do well in its regulatory landscape. In this context, we look at the regulatory landscape in California – a state with the highest solar penetration in the US outside of Hawaii. California Public Utilities Commission, or CPUC, after much contentious dialogue, announced a much awaited new rate design a few weeks back. While not completely unexpected, the rate decision is reflective of ongoing poor rate setting history in California and has severe long term implications for California’s three major Investor Owned Utilities Pacific Gas & Electric (NYSE: PCG ), Southern California Edison [owned by Edison International] (NYSE: EIX ) , San Diego Gas & Electric [owned by Sempra Energy] (NYSE: SRE ) While the decision itself is a long complex document with many nuances, the highlights of the ruling are as follows: – A minimum bill of $10 as opposed to a fixed bill requested by the utilities – Two tiered rate structure with a 25% cost difference between the tiers – A new super user rate for heavy electric users – A relatively accelerated path to TOU rate structures – 4 year glide path to new tiered rate structures Almost all of these decisions, except for the TOU rate structures, while directionally positive compared to the prior rate structures, fall woefully short of what is required to align California electric rates with the market forces. In evaluating the decision, it is instructive to understand the parameters that the PUC set for itself for this rate design. The so-called rate design principles, RDP, adopted by the Commission are as follows: 1. Low-income and medical baseline customers should have access to enough electricity to ensure basic needs (such as health and comfort) are met at an affordable cost; 2. Rates should be based on marginal cost; 3. Rates should be based on cost-causation principles; 4. Rates should encourage conservation and energy efficiency; 5. Rates should encourage reduction of both coincident and non-coincident peak demand; 6. Rates should be stable and understandable and provide customer choice; 7. Rates should generally avoid cross-subsidies, unless the cross-subsidies appropriately support explicit state policy goals; 8. Incentives should be explicit and transparent; 9. Rates should encourage economically efficient decision-making; 10. Transitions to new rate structures should emphasize customer education and outreach that enhances customer understanding and acceptance of new rates, and minimizes and appropriately considers the bill impacts associated with such transitions. What is most ironic about these rate design principles is that many of these goals are in conflict with each other and there is not a single criteria that mentions the goal as delivering low cost long term electricity to consumers. Understandably, a look at the pricing difference between California IOUs and municipal utilities (image below from energy.ca.gov) indicates that CPUC has largely been a failure in delivering low prices to California consumers. (click to enlarge) The root of the problem related to CPUC’s incoherent principles and an over reliance on cost based metrics, instead of market based metrics, in setting utility directives. This poor process has led to historical over investment in assets to justify a higher return to the IOU shareholders. This worked reasonably well for all involved (except customers) as long as there was no competition to the utilities. However, solar energy, and to a lesser degree, wind energy, are dramatically changing the market place dynamics. With many alternate sources of distributed generation accessible to customers, utilities are no longer the energy generating monopolies they used to be. The CPUC, unfortunately, continues to see consumers as subjects that pay the rates they set without considering that the electric generation landscape has changed and the consumer today has choices. CPUC rate structures hide many different subsidies in the form of volumetric rate structures. These subsidies will be problematic to utilities because they are not applied evenly across all the energy sources and will be increasingly coming at the expense of utilities. By being oblivious or nearly completely ignoring market forces, the CPUC is on the course to making utilities a lot less relevant for a big part of its customer base. Given the exponential growth in solar, this subsidy structure will start exacting an increasingly heavier toll on these utilities. The problem, especially in California, is likely to get worse if the PUC continues with its net metering policies and layers in subsidies for battery technologies on top of the already expensive other subsidies. Unless Pacific Gas & Electric, Southern California Edison, and San Diego Gas & Electric can meaningfully alter this regulatory landscape, their future in California will be threatened. Investors will do well to stay away from these and other utilities that operate in an archaic framework that does not properly recognize the threat of solar to the utility business models. We see Pacific Gas & Electric as one of the highest risk utilities. Our view on PCG: Avoid

Why You Should Hunt For Value Rather Than Chase Momentum

“Everything old is new again.” I’ve been acquiring Wal-Mart in the low $60s for many of my clients. A dividend aristocrat with a 3%-plus yield, the stock is paying me to be patient. An old-timer like Hess Corp trading at 2012 prices and less than 1x book (P/B 0.75) is worthy of consideration, especially with its 1.8% dividend yield. I expect U.S. equities to retest their late August lows. Still, there’s nothing wrong with having a “buy lower” value orientation. I raised my daughter in Orange County, California. Beaches, boats, palm trees, friends with fancy cars – life could have been a whole lot more difficult. Spoiled senseless? Not really. She worked three jobs (martial arts assistant instructor, science tutor, husbandry intern at the Dana Point Ocean Institute), while maintaining a 4.4 GPA at her high school. Today, she’s a biology major with a marine minor at the University of California at San Diego. My kid is nineteen years old now. And even though she hasn’t lived at home for about a year, I cannot say that I am crazy about seeing her one weekend a month. So my wife and I asked her to join us in New York this past week. That’s right. Before heading back to DNA replication in one of her two lab internships – before resuming sorority obligations, hanging out with her surf-loving boyfriend and attending biodiversity lectures – my not-so-little piece of my heart had an opportunity to see her father’s hometown. “What do you think?” I asked, barely recognizing the area myself. She hadn’t really paid much attention to the east coast slice of suburbia when she visited 17 years earlier. “Everything seems extremely old,” she replied. She didn’t say “quaint” or “unique,” and it hurt my feelings for some reason. I let her know that not every car is a Tesla. I told her that some brick buildings have character – a whole lot more charm than stucco. I even felt the need to mention that some of the oldest and most successful public companies – Alcoa (NYSE: AA ), Bristol-Myers Squibb (NYSE: BMY ), MetLife (NYSE: MET ), Hess Corp (NYSE: HES ) – had their headquarters in the state of New York. Not surprisingly, my kid gave me one of those “you don’t get it” stares. Perhaps, if I had brought up names like Facebook (NASDAQ: FB ) or Amazon (NASDAQ: AMZN ) or Netflix (NASDAQ: NFLX ), we would have been speaking the same language. And yet, that’s when it hit me. Pizazz at any price is a hallmark of latter-stage stock market bulls. Indeed, whereas every major sector ETF of the economy trades below its 200-day moving average, First Trust Internet (NYSEARCA: FDN ) trades above its trendline; whereas nearly all of the major sectors are negative year to date, FDN is up more than 10%. I realize that there are a whole lot of folks who believe in the forward growth potential of Internet juggernauts like Facebook ( FB ) and Netflix ( NFLX ). I don’t blame you for thinking that they cannot lose 50%, 60%, 70% of their value over the next few years. The thing is, in my 25 years of experience, peaking margin debt is the least kind to the flashiest and the sexist of stocks. Ever heard the phrase, “everything old is new again”? Well, that’s why I’ve been acquiring Wal-Mart (NYSE: WMT ) in the low $60s for many of my clients. Can’t compete with Amazon, you say? I say that a dividend aristocrat with a 3%-plus yield is paying me to be patient. And what’s wrong with paying 2012 prices while we wait? Ditto for Hess Corp ( HES ). I realize that the doom-n-gloom on the commodity has been “spot on.” That said, the U.S. and the global community still depend on oil; that is, whether people around the world are using it for power or a country requires exporting the commodity for its survival, “black gold” will stage a comeback. It follows that an old-timer like Hess Corp ( HES ) trading at 2012 prices at less than 1x book (P/B 0.75) is worthy of consideration, especially with its 1.8% dividend yield. Don’t get me wrong. I expect U.S. equities to retest their late August lows. And I would not be surprised to see the corrective activity break to bearish levels of 20% below all-time records. The vast majority of the 15 warning signs that I outlined prior to the August-September sell-off are still in play. Still, there’s nothing wrong with having a “buy lower” value orientation. If a 33% discount on WMT stock is not enough protection, you might choose a stop-limit order to keep a loss manageable. If you fear $30 oil and worry that HES won’t be able to stand the heat, consider dollar-cost averaging into a diversified sector ETF like iShares Energy (NYSEARCA: IYE ). The one thing that you shouldn’t do? Join the biotech bandwagon or the Internet parade without a plan to step aside. Only 15% of S&P 500 stocks are trading above the 50-day moving average. Market breadth this weak tends to beget more selling pressure. Equally disconcerting? The American Association of Individual Investors (AAII) has investor bullishness at a 2-month high of 34.7%. Historically, you will get a whole lot more folks throwing up the white surrender flag before a corrective phase finishes. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Ormat Technologies Is An Unrecognized Alternative Energy Play

Summary Geothermal is a small but fast-growing and important part of the growing alternative electricity generating space. Ormat is an industry leader with significant new capacity coming online. The Ormat Energy Converter technology is a patent protected process that gives the company a competitive advantage in the space. We believe that ORA will eventually be valued like the high-yielding electric utilities as it boosts its dividend payout with strong free cash flow growth. Ormat Technologies (NYSE: ORA ) is a global leader in geothermal energy technology, which we think will be a net market share adder over the next half decade. The path towards expanded margins and stronger earnings growth has become more clear, which we think should re-rate the shares higher over the course of the next year. We think the company has completed a significant amount of strategic initiatives over the last year which is unlocking substantial shareholder value. Those key catalysts, which we believe should reward shareholders, include: Share exchange completion with Ormat acquiring parent company in order to get listed on the TA-25 Index. Underlying growth in the space should realize a double-digit CAGR through 2020, propelling earnings. Its patented Ormat Energy Converter technology provides a competitive advantage. Company Description The company is the leader in the geothermal and recovered energy power generation business. The company builds and operates environmentally-friendly geothermal and recovered energy-based power plants, typically using equipment that it designs and manufactures. Most of the operating portfolio is in the US, Kenya, and Guatemala. The firm has a ~80% market share in the geothermal binary power market segment. The company has two reporting segments: electricity revenues and product sales. Electricity revenue represents two-thirds of revenue and 63% of operating income. The company has 50 years of experience in the space and owns and operates approximately 650 MW of power generation. (click to enlarge) Source: Corporate Presentation Long-Term Opportunity Potential We think geothermal is an overlooked area of alternative energy investment that holds many of the strong properties that are sought after by both investors and power generation companies. The essential properties of geothermal technology tap the heat from the Earth that escapes through various fissures as gas or water. Hydrothermal geothermal-electricity generation is derived from naturally occurring reservoirs of heat that are formed when water comes in contact with hot rock or through “escaping” heat of 300 degrees or more. The heated water rises to the surface and is extracted through geothermal wells, typically located within a few miles of a power plant. The key is if natural ground water sources and reinjected, extracted geothermal liquids are adequate to continuously replenish the geothermal reservoir creating a long-term renewable energy source. Geothermal in the US currently generates approximately 13 GW of geothermal energy. This is enough electricity to power approximately 20 million US homes, but represents just 0.2% of global electricity generating capacity with very low penetration. In the last year, the globe added 700 MW of additional capacity in 2014. Third-party forecasts as well as the Geothermal Energy Association (GEA) predict 10%-12% annual growth through the end of 2020. Bloomberg predicts that by 2030, capacity will grow to 40 GW, representing 270% capacity growth over the next eighteen years. Even with that massive growth, the percentage of power generated from geothermal would still be less than half a percent. The reason for the growth is the base-load potential of the source, meaning that it has a long-life potential (~30 years) and is cost competitive with coal and gas. Source: Bloomberg Energy Finance 2013 Proprietary Technology In Binary Plants A Differentiator Binary power plants are operated using the Organic Rankine Cycle where heat is transferred to a fluid at constant pressure. The fluid is then vaporized and then expanded in a vapor turbine that drives a generator, producing electricity. The company has proprietary technology that can be used in binary power plants to recover energy generation to capture unused heat derived from the industrial processes. This can be converted into electricity using the Rankine system. Ormat has a proprietary system called the Ormat Energy Converter which fulfills this purpose in both binary and REG systems. The whole system has been designed by Ormat including the turbines, pumps, and heat exchangers, as well as formulation of organic motive fluids, all of which are environmentally friendly. The company also patented and developed GCCU power plants in which the steam first produces power in a backpressure steam turbine and then is condensed into a binary power plant, producing additional power compared to conventional methods. We think ORA’s technology has a number of competitive advantages compared to its competition. Conventional steam plants can consume a substantial amount of water, causing depletion of aquifers. In the US, most of the natural geological geothermal energy plants and sources are in the West, namely Nevada, California, Arizona, Utah and Idaho. These are areas where water is a valuable commodity, meaning water-saving technology is far superior to conventional steam methods. ORA’s binary technology also has lower visual impact which can be aesthetically unappealing to residents in the localities. Traditional steam models have to have large cooling towers which emit exhaust plumes during cool weather. Ormat’s technology does not have emissions when using its geothermal fluid technologies. Other competitive strengths include the ease of operation and low maintenance. This is derived from the lack of contact between the turbine blade and geothermal fluids, which tends to have a corrosive effect. Instead, the company’s technology passes the fluids through a heat exchanger, which creates less friction and can withstand corrosive fluids better. We think its moat and competitive advantages are a strong positive on the shares. Between the focus on geothermal binary and recovered energy generation, ORA’s proprietary energy conversion technology and its global expertise separate it from the competition. Margin Expansion Story Underway The business lends itself to significant scale advantages with margins growing to 36.4% last year and 37.3% over the trailing twelve-month period. EBITDA margins are up to 47.8%, up 1,000 bps over fiscal 2013. We think margins should continue to expand bolstered by the electricity segment which has several natural advantages to scale. Some of that margin expansion will come from stronger pricing per MWh. We think the expansion of new capacity over the next two years along with increased utilization should help the segment achieve 40%+ gross margins on an annual basis. The product segment is also seeing much strong margins growing from 27% to the current 38.4%, a significant increase. The business can see more lumpy margin expansion and contraction depending on product mix and EPC service. We think it’s an important driver of the value-add in the business as it’s far superior to other alternative power companies like solar and wind. State And Federal Push Into Renewables Renewable portfolio goals have been set in 40 states which require state-based utilities to generate or import a certain percentage of their electricity from renewable energy or recovered heat sources. California, for instance, established one of the first renewable portfolio standards which requires 25% of electricity generation and usage by renewable, and 33% by 2020. Another state, Hawaii, has an ambitious goal of achieving 100% renewable energy generation by 2045. Hawaii has a significant amount of geothermal activity which can utilize Ormat’s technology, and we believe that it will be a significant contributor in the portfolio of renewable power generation. As costs of renewable energy generation continues to come down and when factoring in ancillary costs of CO2-emitting power generation, we think states will continue to raise renewable standards and goals towards at least 50%. Depending on the location, geothermal will likely be an important part of that renewables portfolio. Remember, geothermal power generation does not need to be the majority or even one of the top three sources for Ormat to see a significant boost in revenue. The Federal government does not have a set renewable portfolio goal, but through the EPA, has been pushing up renewable usage through the implementation of additional regulations onto CO2-emitting power generation, namely coal. This was done by the Obama administration in 2013 which directed the EPA to create new pollution standards for new and existing power plants. In this clean power plan, the goal is to cut carbon emission from the power sector by 30% below 2005 levels nationwide by 2030. Movement towards renewables, while not explicitly cited, is a key factor in achieving those ends. Valuation The shares amid the global sell-off trade at just 9.6x ttm EV/EBITDA, which we believe is a discount given the shift towards higher-margin electricity segment revenue generation. We used a sum-of-the-parts analysis of the business to more accurately assess the value of the shares. The electricity segment is similar to many of the publicly-traded utilities that are power generators. The only real difference is the source of the power generated coming from geothermal rather than coal or natural gas. Using the public utilities as comps, the shares are trading at a slight discount to others like PPL Corp. (NYSE: PPL ), NRG Yield, Inc. (NYSE: NYLD ), TerraForm Power (NASDAQ: TERP ), and NextEra (NYSE: NEE ), but ahead of some other peers like TransAlta (NYSE: TA ), AES Corp. (NYSE: AES ), and Abengoa (NASDAQ: ABGB ). The peer group comps have a median average of 8.9x, which is slightly ahead of the ntm EV/EBITDA ratio for Ormat at 8.5x. We think that the product segment is holding back the consolidated ratio, but given the growth in the business’s margins, we think that could be changing. In addition, we see the electricity segment as gaining scale which is expanding its margin significantly towards 40%. As such, we do think the consolidated multiple should expand towards 9.0x. We applied a 5.5x multiple to the product segment, which we think is fairly conservative, but given the size of the business, it’s not a significant driver to the consolidated multiple. On the electricity side, the margins should be at least in line with the comps. We could make the argument that the electricity segment should receive a premium valuation and that the product multiple is too conservative. We estimate $285 million in EBITDA net of the company’s Northleaf JV ownership. We think the shares are worth $42 using those fairly low multiples. Conclusion We believe Ormat is an ignored alternative energy company. While the market seems to cater towards the solar and wind companies, we think the geothermal space is actually superior to the economics of those two alternative energy segments. We think the shares are worth approximately $42 and that the long-term trends within the space are very strong. The company is bringing on significant new capacity over the next two years while it becomes more efficient and gains scale, boosting its margins and profitability. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.