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PPL's spin-off of generation business tied to price of natural gas

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These days, PPL Corp. derives 85 percent of its earnings from its regulated utilities. The rest comes from its electric generation and other businesses.

But just five years ago, that statistic was flipped, when electric generation provided the bulk of the company's earnings, said George Lewis, PPL's corporate communications director.

“That's driven by the differences in the two businesses,” he said. “Low natural-gas prices have been driving down wholesale power prices.”

Couple that with conservation efforts and environmental regulations, and you can see why PPL announced earlier this month it was spinning off its electric supply business and merging it with Riverstone Holdings LLC to create Talen Energy Corp.

It's a growing trend. Bloomberg recently reported that Duke Energy Corp., the largest U.S. utility owner, said it plans to sell its interest in 13 Midwestern power units. Also, American Electric Power Co. is looking at whether it will sell plants later this year or early next year.

Strategic move

For PPL, the move is strategic, said Daniel White, a director at Berkeley Research Group LLC, an expert services and consulting firm.

Regulated utilities are usually pretty solid performers in terms of stock price. The return is small, maybe 10 percent. But it is reliable.

That's not the case with competitive energy generation.

“Utility stockholders are seeking stable returns that come from operating within a regulated environment, while energy commodity markets can be highly volatile and, as to U.S. gas and power markets, are currently perceived as a tough market for suppliers,” White said. “Companies in that environment need to be nimble and drive to be the lowest cost producer, which are not utility strengths.”

In an analysis from November, M. Tyson Brown, an analyst with the federal Energy Information Administration, noted that more reliance on natural gas to generate electricity caused the price of power to fall from 2008 to 2013.

The price of electricity in the PJM West market, which includes the midstate, went from about $80 per megawatt hour in January 2008 to less than $4 in January 2013. At the same time, the price of natural gas went from just shy of $120 per million BTUs to about $4.

“Although natural gas-fired units do not make up a majority of the generation units in this region, these units often set the wholesale electricity price,” Brown wrote. “This is because in the PJM market, the electricity price is determined by the last unit selected (the marginal unit) to run at a given time, based on fuel and other operating costs. Because natural gas often fuels the last unit selected, the wholesale power price in the PJM system generally moves with the natural gas price on any given day.”

Meanwhile, thanks to strong production of natural gas from the Marcellus Shale formation in sections of Pennsylvania, Ohio and West Virginia, gas price volatility has been reduced, White said.

“This has contributed to a reduction in the profit opportunities in marketing and trading power and gas, and the perception is that state of affairs will continue,” he said. “This is leading to a reshuffling of the participants in both competitive gas marketing and trading, and competitive power marketing and trading. For example, companies that are (predominantly) trading oriented (for example, JPMorgan) have been exiting the gas marketing and trading sector.”

Refocus

Hence, PPL began to refocus on regulated utilities and, ultimately, to split off electric generation, Lewis said.

“The shareholders were looking for more stability and a stronger dividend, a more conservative investment,” he said. “So we increased the size of our regulated utility business by making acquisitions in Kentucky and U.K. that made a greater overall shift toward the regulated utility business. That was able to provide that stability and that solid dividend that utility investors are looking for.”

Since Talen is expected to be listed on the New York Stock Exchange, it also gives a better investment to those who want the risks associated with competitive generation, White said.

“From a corporate perspective, the power marketing business is a drag on their returns on their utility investments,” he said. “They'll be able to make decisions and not have to think about where they spend money and don't spend their money in their power plants.” 

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