December 31, 2001; Seasonal Strength in Electricity Good for Natural Gas Producers

Electricity futures point to price strength in the hot summer months of July and August.  A positive spread between the price of electricity and the price of natural gas implies profitable operations for companies that generate electricity from natural gas (see Chart).  It implies even more profitability in an unregulated environment for companies that generate electricity from low cost coal and nuclear plants such as those owned by recommended American Electric Power (AEP) and Exelon (EXC).

There is remarkable operating leverage in electricity for natural gas producers as evident by price swings on the chart above compared to the chart for natural gas.  In the off-season there is enough cheap coal and nuclear capacity that we don't need much gas to be converted to electricity.  In the peak season we need natural gas.  Moreover, generators can afford to pay a lot.  As electricity demand grows, cheap capacity will remain fixed while natural gas fueled generators meet incremental demand.  The peaks we see on the price curve will spread increasingly across the year.