TXU purchasers are on the road telling investors about the value of their decision to buy the utility for $45 Billion. As is made clear in an article published on Star-Telegram.com titled TXU buyers bet on higher natural gas prices, one of the major factors that will make the decision a good one is the price of natural gas in Texas. The higher the price of that commodity, the more money the utility will make and the more valuable the stock will be.
That analysis may not be intuitively obvious since about half of TXU’s generating capacity burns natural gas, but when one looks at the actual electricity production from the company the story becomes more clear. As of 2006, only about 6% of TXU production comes from burning gas – most of the gas fired capacity in the system is in peaking plants that rarely operate. The vast majority of TXU production comes from coal and nuclear plants whose fuel costs are much lower and more stable than those of the gas fired plants.
Since Texas electrical markets are partially deregulated, the market price is set by the highest cost generators. Those are usually companies that depend on natural gas as their main supply. Companies with substantial quantities of lower cost generation can make a huge rate of return in that kind of market.
Here are some numbers for thought – according to figures published by the Nuclear Energy Institute the average cost of generation (in US dollar cents per kilowatt-hour) from various sources in 2006 was as follows:
Coal – 2.37
Gas – 6.75
Petroleum – 9.63
Nuclear – 1.72
If you are a company with mostly depreciated coal and nuclear assets (since most of TXU’s plants are more than 25 years old, they qualify) you can manufacture electricity for well under 50% of the market price. That is a huge margin for a high volume commodity.
Here is the explanation in the words of the company:
David Campbell, TXU’s chief financial officer, explained the company’s hedging strategy in a July interview, noting that TXU’s coal and nuclear plants “are like a natural gas field” that TXU owns.
“They produce power at the cost of coal and nuclear, but the price is driven by the wholesale market in Texas, and that price is set by natural gas,” he said.
That is something to think about.