Some sub-sectors of the energy industry stand out for their growth prospects, analysts say.
Ron Barone
Shneur Gershuni
UBS
212-713-3848, 3974
Area of Coverage: Coal
Outlook: We think the outlook for coal is really good. The reason why we say it's quite favorable is that the U.S. production of natural gas is continuing to decline. It would take the better part of 10 to 12 years to build a new nuclear power plant. Coal is the only thing we've got to bridge the gap for the power industry from gas generation to nuclear power generation.
There are several electric utilities turning to coal right now. Here are the exact number of megawatts of coal under construction and coming online by 2010: The coal industry has 400 megawatts coming online in 2006; 1,430 megawatts in 2007; 1,070 in 2008; 8,514 in 2009; and 20, 411 in 2010.
Only in the past three years have people acknowledged that it's OK to build a coal plant. The whole idea of scrubbing technology has played an important part in this acceptance along with fact that the price of gas will not return to $2 anytime soon or for any sustained period of time. Even two years ago, no one thought it was for real that gas prices were on the move to a much higher level. Now it's accepted. So when you do least-cost planning to build a new generation facility and you start to consider all the costs of the fuels as well as plant construction costs, coal makes economic sense.
Six years ago, every facility being built was natural gas. People have realized that the U.S. is running out. Liquefied natural gas is years away. I don't think people can bank on it, and it's not going to be cheap. We are not concerned about fuel switching at current natural gas prices. Coal inventories are more likely to increase than to decrease from here, and the harsh decline in coal prices is likely short-lived. We believe coal equities are set to rebound.
Outperforms: Alpha Natural Resources (ANR); Foundation Coal Holdings (FCL); International Coal Group (ICO) and Peabody Coal (BTU)
Top Pick: Peabody Coal
Why Peabody: Peabody has a great long-term fundamental story. It has scale, geographic diversification, a long-lived reserve base, and can play multiple coal strategies (e.g., clean coal, high sulfur coal, and metallurgical coal). The company's pending acquisition of Australian producer Excel Coal will be accretive and represents a good use of cash.
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Michael C. Heim
A.G. Edwards & Sons, Inc.
314-955-3272
Area of Coverage: Gas Utilities
Outlook: We maintain a neutral stance toward the group as a whole with a positive bias toward those gas utilities with unregulated energy production. There were a number of developments that influenced our appraisal. Interest rates rose and could continue to rise. The yield on 30-year government Treasury bonds rose 6 percent during the quarter to 5.2 percent. We expect bond yields to continue climbing as higher commodity prices work their way into inflation numbers.
Gas prices have fallen, but the natural gas futures curve shows prices rising sharply this fall. While spot prices have fallen, upcoming winter contracts have remained above $10. The futures curve is not a perfect predictor of price movement, but it does indicate what price producers can receive for future production.
Consumers are conserving energy in reaction to higher utility bills. Gas distributors reported decreased weather-normalized gas usage in the first quarter. The decreases reported range from "mild" to 5 percent.
Gas utility stock valuations have come down from peak levels reached in September 2005 in response to rising interest rates and concerns regarding bad-debt expense and conservation. At current prices, gas utility stocks are trading at the mid point of our perceived trading ranges on both an absolute and a relative basis.
Buy-rated stocks: Energen Corp (EGN); MDU Resources Group (MDU); Questar Corp (STR); and Sempra Energy (SRE)
