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Content-Type: text/plain; charset=ANSI_X3.4-1968 Content-Transfer-Encoding: 7bit X-From: Mark Koenig X-To: Steven J Kean X-cc: X-bcc: X-Folder: \Steven_Kean_June2001_3\Notes Folders\California X-Origin: KEAN-S X-FileName: skean.nsf FYI ---------------------- Forwarded by Mark Koenig/Corp/Enron on 01/12/2001 10:14 AM --------------------------- firstcall.notes@tfn.com on 01/12/2001 01:17:14 PM To: mark.koenig@enron.com cc: Subject: UPDATE OF CALIFORNIA CRISIS AND BRIEF NOTES ON DUKE ENERGY CONFERENCE CALL FIRST CALL RESEARCH NETWORK 10:41am EST 12-Jan-01 Prudential (C.COALE 713-650-4732) DUK DYN ENE REI PCG UPDATE OF CALIFORNIA CRISIS AND BRIEF NOTES ON DUKE ENERGY CONFERENCE CALL UPDATE OF CALIFORNIA CRISIS AND BRIEF NOTES ON DUKE ENERGY CONFERENCE CALL PRUDENTIAL SECURITIES January 12, 2001 SUBJECT: Natural Gas Distr./Pipelines ----- ANALYST(S) -------------------- -------- OPINION -------- M. Carol Coale 713.650.4732 Current: Strong Buy David R. Tameron 713.650.4731 Risk: Moderate ----- HIGHLIGHTS--------------------------------------------------------- Key players in California energy crisis meeting continuing to meet in Washington - nothing material has yet to be finalized. Our expectations are detailed within. 1) Cautioning investors to avoid stocks with California exposure until a more longer term solution is decided upon. However, the lowest risk is likely in the cheapest stocks, and DUK may be the best bet over the week or so. DYN in the mid-$30s and ENE in the mid-$60s are also attractive. 2) Duke Energy conference call reiterated that about 90% of California portfolio is hedged forward with non-utilities or in transactions outside of the Independent System Operator (ISO) or Power Exchange (PX). We estimate Duke's financial exposure is less than $0.04 per share annually. ----- DISCUSSION---------------------------------------------------------Thoughts on California and brief comments on the Duke Energy Conference Call. Key representatives of the California utilities, power generators, marketers have been in meetings in Washington D.C. with the FERC Chairman, Secretary of Energy, U.S. Treasurer and members of the Clinton staff. We have the following comments on what we believe may be and should be long-term solutions to the California energy crisis. What we think will come out of Washington meetings: 1) Power generators will agree to selling power under long-term (up to 10 year) contracts at the capped retail rates ($65-$75/Megawatt hour (MWh) assuming that they can buy gas supply forward. However that market is very illiquid and can take weeks to secure a transaction. 2) Politicians/legislators want to avoid bankruptcies, but we still think there is a 50/50 probability. 3) Utilities likely to be able to buy/sell electricity in forward market. 4) California is likely to eliminate the Power Exchange (PX) and replace with negotiated buy/sell market. 5) "Forbearance" brings up issues of whether the utility can defer payments for power supply for a number of periods or whether the state will pick up the bills. The impact on the receivables of the power generators/marketers and lenders is uncertain. 6) We believe actual seizure of power plants from the unregulated suppliers by the state is unlikely, as is the removal of emissions credits (also, we understand NOx emissions credits can be as high as $46/Megawatt hour in California). 7) Resignation of reigning FERC Commissioner Jim Hoecker on 1/18/01 allows for Bush-appointed commissioner to step in, most likely to be Republican Curt Hebert. Herbert has been vehemently opposed to price caps and supports competitive markets. 8) Under a "new FERC", we think there is a low risk of retroactive repercussions on generators to "give back" past profits on electricity sold in California last summer, and also that a windfall profits tax on generators/marketers is unlikely. 9) Companies such as DUK, DYN and ENE all appear to have less than $0.05 per share of annual earnings exposure to California generation/marketing sales net of risk mitigation. However, recent conversations with Reliant Energy have revealed that it has not hedged its receivables risk with the utilities in California. Typical monthly receivable balances range from $5-$270 million or up to $0.60 of earnings exposure. REI is betting on the risk of bankruptcy of PG&E and Edison is unlikely, and therefore, the cost to set of credit reserves at this point would more than outweigh potential earnings exposure. 10) While these stocks, in addition to REI, appear oversold, the stock performance is likely to be volatile until a solution to the CA energy crisis is introduced. In our view, the California market solutions fall short of the big picture. I have been cautioning investors to avoid the above-mentioned stocks until a more longer-term solution is decided upon. However, the lowest risk is likely in the cheapest stocks, and DUK may be the best bet over the week or so. Still, DYN in the mid-$30s and ENE in the mid-$60s are also attractive, in our view. 11) We expect DYN, DUK, ENE and REI to all report positive 4Q01 earnings surprises of at least a penny or so, but to the extent that the surprise is related to power generation, the stocks may not react favorably. What we think will solve the California problem: 1) Eliminate all retail rate freezes, and let the market forces balance supply and demand. Higher electricity prices to the consumer will encourage less use and the purchase of more efficient energy equipment, and will also encourage independent generators to build new facilities. 2) We agree with the allowance of forward sales and a free spot market for unregulated electricity transactions. 3) A word on the hydroelectric generators. Most are government-owned facilities that virtually generate electricity for "free". It would stand to reason that the hydroelectric generators (a.k.a. the federal government) has been financial benefiting from selling "free" power into a market that has been marginally priced off of high-priced natural gas. Shouldn't the government also be asked to "share the pain"? Following highlights from DUK call: 1) Duke controls or owns 3,300 megawatts of electric generating capacity out of a portfolio of about 6,000 megawatts. About 90% of its California portfolio is hedged forward with third parties that are not utilities or in transactions involving the Independent System Operator or Power Exchange. 2) Duke's receivables "at risk" are not material financially or operationally, according to the company. Duke pointed out that just over 10% of EBIT is generated from its wholesale energy business, although we estimate it is closer to 15%. 3) Duke has a minimal number of contracts with PG&E and SoCal Ed (EIX subsidiary). 4) Nothing material has been agreed upon in the Washington meetings between industry representatives, legislators and feds, but the likelihood of power plant seizures and retroactive penalties appear unlikely. 5) We estimate DUK's annual financial exposure, net of forward sales, is less than $0.04 per share annually. Stocks mentioned in this note include: Duke Energy (DUK-65 7/8; rated Accumulate); Dynegy (DYN-39 ?; rated Accumulate); Edison International (EIX-10 r; not rated); Enron Corp. (ENE-69 7/16; rated Strong Buy); PG&E Corp. (PCG-12 5/16; rated Sell); Reliant Energy (REI-32 7/16; rated Hold). Prudential Securities Incorporated (or one of its affiliates or subsidiaries) or its officers, directors, analysts, employees, agents, independent contractors, or consultants may have positions in securities or commodities referred to herein and may, as principal or agent, buy and sell such securities or commodities. First Call Corporation, a Thomson Financial company. All rights reserved. 888.558.2500 Note ID: 402321 ------------------------------------------------------------------------------ To update your order or to receive research on other companies, please call your Account Manager at (800) 262-6000. ------------------------------------------------------------------------------ Thomson Financial Investor Relations TEL: 800-262-6000 75 Wall Street, 18th Floor FAX: 212-363-3971 New York, NY 10005 EMAIL: firstcall.notes@tfn.com First Call is a registered trademark of the First Call Corporation
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