Coal Isn’t the Only Power Source Hurt by Natural Gas: Exelon Corporation (EXC)

By now it’s no secret that natural gas has displaced large amounts of coal in the nation’s power grid. The fuel is widely abundant and easily transportable, and it releases fewer emissions across the board than dinosaur rocks do. Switching production and capacity from one to the other is often a no-brainer for utility companies.

It may not be as obvious that cheap natural gas has also targeted the third largest source of electricity generation: nuclear. Since nuclear won’t be displaced, the effect won’t be as dramatic as that felt by coal. In fact, the Energy Information Administration expects nuclear to maintain a nearly 20% share of the country’s total electricity capacity for the next several decades.

But as coal has demonstrated, pricing advantages trump market share.

Pricing pressure slashes dividend
Nuclear facilities, which aren’t affected by the direction of oil and gas prices, have little power in positioning their product to compete with cheaper natural gas. While uranium prices currently sit at multiyear lows of $44 per pound — well below the all-time highs of $143 per pound in 2007 — that’s still not enough to be competitive. Consider that the average uranium-to-natural gas price ratio was 0.21 in 2008, but it more than doubled to 0.51 in 2012.

This reality is becoming painfully obvious for Exelon Corporation (NYSE:EXC), which owes 54% of its capacity to nuclear plants. Shareholders were delighted to see 2012 earnings fall within the company’s guidance, but they face upcoming battles in 2013. Despite the “strong year of operational performance,” President and CEO Christopher Crane effectively conceded that the company’s dividend is unsustainable by announcing a sharp reduction in distributions. The new dividend will be $1.24 per share on an annualized basis, 41% lower than the previous $2.10 payout.

Don’t get me wrong. Cutting the dividend, which still yields 4%, is absolutely the right move to make. But it also highlights anticipated headwinds. Revenue soared 30% to $24.67 billion in 2012, but net income fell almost 16% compared with 2011. It marked the fourth consecutive year that profits have fallen at the energy company.

Industry roundup
Exelon is one of the nation’s largest energy providers, with nearly 35,000 megawatts of total annual capacity. The company easily outpaces its peers with 19,000 megawatts of nuclear capacity.

Sources: Company annual reports

The company’s allocation of assets, with just 28% of total capacity consisting of natural gas, certainly seems to be dragging on income. There are no rules or guidelines for how to best distribute a massive energy portfolio, but Exelon’s is clearly best suited for a different market. A quick comparison with its peers demonstrates this fact, but it also highlights the growing importance of natural gas.

Natural gas powered almost 58% of NextEra’s portfolio in 2011, which grew the company’s adjusted EPS to $4.57 per share last year. While the company has strategic nuclear capacity, it is much more focused on growing its renewable assets and added a record 1,500 MW of wind capacity in 2012.

Duke Energy merged with Progress Energy in 2012 and inherited the ailing Crystal River nuclear plant in the process. The new company recently announced that it will retire the facility and consider replacing it with — what else? — a state-of-the-art natural gas power plant. The company’s portfolio was much too heavy in coal, which comprised 41% of capacity before the merger, at the beginning of 2012. Natural gas made up just 28% before the merger.

NRG Energy doesn’t bring much nuclear capacity to the table, but it does support more than 37% of its total generation capacity with natural gas. A recent merger with GenOn created the country’s largest provider, with more than 47,000 MW of capacity. Similar to NextEra, NRG is focused on building its renewable portfolio with its eVgo charging network, which aims to make electric vehicles more feasible for the everyday consumer.

What can be done?
Two things can help nuclear regain competitiveness: a better pricing environment and tighter regulations on emissions. The EIA expects natural gas prices to gradually appreciate over the coming years, while infrastructure expenditures passed on to the consumer will result in higher electricity prices across the country.

While nuclear facilities undergo regular enhancements, the cost is unlikely to make any major contribution to national electricity prices, which will help close the gap against natural gas. For instance, The Southern Company (NYSE:SO) got the nod last year to build two new reactors at a cost of $14 billion. After accounting for a Department of Energy loan, the company is responsible for $6 billion, which will raise its customers’ energy bills by just 1% each year for the next five years.

Stricter emissions regulations, which will be a major initiative for the White House in the next four years, could also improve nuclear energy’s outlook. Natural gas is cleaner burning than coal in most major emissions categories (except methane), but nothing beats a string of goose eggs:

Source: EPA.

According to the U.S. Department of Energy, nuclear power plants avoided 613 million metric tons of CO2 emissions in 2011. That’s the same total produced by 118 million cars, which is nearly the same number of cars in the United States.

Although a carbon tax would have the biggest positive impact on nuclear-generated electricity prices, the White House has hinted that it accepts natural gas as the lesser of two evils. Recent emissions standards have set the bar out of coal’s reach and favorably within that of natural gas.

Foolish bottom line
There’s no reason to believe energy providers won’t grow in 2013, but each has to successfully navigate the best course forward in an ever-changing market. When it takes years and decades to build capacity, monthly or yearly changes in energy prices are difficult to respond to. So don’t expect Exelon to dump its nuclear capacity just because the current market is less favorable to uranium.

The article Coal Isn’t the Only Power Source Hurt by Natural Gas originally appeared on Fool.com and is written by Maxx Chatsko.

Fool contributor Maxx Chatsko has no position in any stocks mentioned. Check out his personal portfolio or follow him on Twitter @BlacknGoldFool to keep up with his writing on energy, bioprocessing, and emerging technologies.The Motley Fool recommends Exelon and Southern Company.

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