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Power Failure: Sorting out the Investment Winners and Losers
New York: August 21, 2003
By John R. Stephenson
Last week we saw something remarkable. The biggest power failure
in the nation’s history. A blackout so massive that some
fifty million people were left without power, some for days,
while governments, utilities and politicians pointed fingers.
While the cause is unknown, the solution is obvious - greater
investment in the electric grid that serves us as consumers.
From an investment perspective who are the likely winners and
losers and what is the best course of action for investors to
follow?
The makings of this disaster go back over a hundred years
to the time when electricity was first invented. Because generating
plants and the associated transmission and distribution lines
(the wires that get the power from the plant to your home)
were so expensive to build and operate, it made little sense
for competing plants to be built. The solution - grant the
utilities monopoly service territories that a local public
utilities commission would oversee to ensure that there were
no abuses of monopoly power. The problem today, is a complex
system straining to meet the demands of a growing nation.
This system is being overseen by overlapping levels of both
governmental and non-governmental agencies with little physical
redundancy whatsoever in the system. As well, we have the
deregulation of the nation’s electricity system occurring
on a piecemeal basis. Confused? Even the experts are confused
as to who was responsible for this massive blackout that crippled
some fifty million people and stalled the economy of the crucial
Northeastern region of the country. Sorting out the mess is
going to take years, not weeks, and given the highly political
nature of the industry today, you can bet that politics will
play a heavy role in the solution to this problem in the years
that lie ahead.
So where do we stand? We can all agree that the energy delivery
system in this country is crucial to our economic development
as a nation and that disruptions of this type pose not only
a danger to our economy but also to our national security.
It is also clear that at least at the present time there exists
tremendous political will, not only in the United States but
also in Canada, to clean up this mess and get a system that
works. Recent studies have shown that to bring the transmission
grid into the twenty-first century will require an investment
of some $56 billion. But where is that money going to flow
and how are you to benefit? Perhaps you should buy the stock
of some of the utilities in the affected areas? Perhaps an
investment in Detroit Edison (DTE) or First Energy (FE) would
make sense? Think again. After it was discovered that four
out of five suspect transmission lines that seemed to be at
the heart of the crisis belonged to First Energy, the stock
sold off hard. Investors worried about the possible liabilities
that First Energy might have if it were found that their portion
of the system was at fault for the blackout. Under the law,
utilities have an obligation to serve, which cuts both ways.
They have a ready customer base, but they also can be left
holding the bag if a major problem occurs that dramatically
affects their customers.
Not only are utilities responsible to the end users of their
product, you and I, but they also have to answer to a wide
variety of agencies and governmental organizations. If they
sell power wholesale to other utilities, their actions are
governed by the Federal Energy Regulatory Authority (FERC).
If they sell their power to retail customers, then the local
public utilities commission (PUC) is the arbiter of their
policies. Should a major disaster occur that affects hundreds
of generation plants and another country, then the feds will
get involved and the utilities will have to cow tow to the
Secretary of Energy. Figuring out the dynamics of the political
machinations of the various levels of government is just too
hard for an investor to do, largely because the politicians
do things for political rather than economic reasons. Trying
to bet the farm on the direction of a political outcome is
just too difficult.
But surely there must be some safer bets? Money is going
to be spent and someone is going to benefit, the only question
is who? If utilities themselves are too difficult for investors
to sort out, then the most likely call is to find a company
that manufactures the critical transmission equipment that
the grid relies upon. In the same way that fortunes were made
by those that sold the picks and shovels for the California
gold rush rather than those actually panning for gold, the
original equipment manufacturers should be the biggest beneficiaries
of all of this new capital investment.
The largest manufacturer of high voltage transmission equipment
is ABB Ltd. a Swedish company. Manufacturers of backup generation
equipment such as diesel generators should also fare well
as this crisis has made it obvious that the contingency plans
that most individuals and businesses have in place is woefully
inadequate. The largest manufacturer of diesel electric generators
in the world is Caterpillar Inc. (CAT). Others have thought
that the solution to the problem is to have small generators,
or microturbines serving single offices in a distributed generation
model. The manufacturers of microturbines all tend to be small
and largely unprofitable, but one company that might benefit
in the short run is Capstone Turbine Corporation (CPST), a
manufacturer of small microturbines. Of course, pure play
transmission companies might be an attractive area of opportunity
for investors, but the leading company in the industry, Trans-Elect,
Inc., which has been gobbling up transmission assets from
some of the behemoths in the industry (companies such as Dynegy
and TransAlta) is a privately held concern.
With money to spend and political will in their corner, the
nation’s electricity grid is in for a much needed facelift.
The likely beneficiaries in the short term are the manufacturers
of transmission equipment and backup generation equipment.
When the political chips have fallen where they may, the utilities
with large transmission systems should be the beneficiaries
of the increased cash flows in the longer term.
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