Progress Energy (NYSE:PGN) is an electric utility with 3.1M customers in North Carolina, South Carolina, and Florida. It produces more than 21,000 MW of electricity which it then sells to residents, businesses, and state and local government offices in the three states in which it operates. PGN has increased its dividend for 20 consecutive years.
Progress' largest costs come from operating its utilities and generating its energy. Fossil fuel prices affect PGNs net income, and as prices for coal climbed the first half of 2008 above $100, doubling its price from the start of year, along with a 67 percent increase in natural gas prices to $13 a million British thermal units, PGN has been forced to continue its search for alternative energy sources. It uses fossil fuels, nuclear, hydro, and solar power to generate energy. It plans to construct a new nuclear power plant, something that has not been done in over three decades. In order for the costs of new investments to be profitable, it will need to make sure demand for its energy stays high. Although residents in the Carolinas and Florida don’t choose their utilities company, leaving PGN free of competition, the number of vacant houses continues to increase, decreasing demand for electricity. During the second quarter of 2008, PGNs residential market in Florida only saw a net increase of 2,000 new customer, a number well below forecasts; however, the Carolinas during the same quarter had strong growth of 25,000 new customers. Utilties is also a market that is heavily regulated by the government; some of its more costly regulations are those of air quality, which force companies like PGN to modernize their infrastructure to release less particulate emissions and greenhouse gases; renewable energy standards will further squeeze PGNs margins in the upcoming years as it invests in building new plants to increase its production of renewable energy from 1 percent to over 10 percent in a lapse of four years.
Progress Energy is a holding company which operates utility subsidiaries. It draws its energy from nuclear, oil and gas, coal, and hydro sources. Nearly 80 percent of its sources come from fossil fuels
Progress Energy’s revenue in 2007 was $9,153M, a 5 percent increase from the previous year. However, its net income fell 13 percent to $504M from $571M. This drop in earnings was due to higher operation and maintenance costs, which had a $94M increase in 2007, a result of higher plant outages and higher employee benefits. Another significant expense was due to the industry's regulatory nature, a $34M of Clean Smokestacks ACT amortization, falling from $140M the previous year. Other costs included PGNs exit of the merchant energy business. With a strong growth in the Carolinas and the increase in revenue from wholesale, PGN has been able to turn around its net earnings during 2Q 2008 to $205M, compared to the same period last year (2Q 2007) where it had a net loss of $193M.
PGNs largest business comes from selling energy to residential consumers; this is done through its subsidiaries PEC and PEF which serve North Carolina and South Carolina, and Florida, respectively.
PEC is one of PGNs subsidiaries which generates and distributes electricity to North Carolina and northeastern South Carolina, covering about 34,000 square miles. PEC has had a strong growth during the 2Q of 2008 with a total of 25,000 new customers who have just been added.
PEF is one of PGNs subsidiaries which generates and distributes electricity to portions of Florida, about 20,000 square miles in west central Florida. With a growing number of vacant houses, PEF had minimal growth during the 2Q of 2008, only 2,000 new customers were gained.
PGN uses alternative energy sources like solar power, nuclear, hydrogen and biomass. Producing alternative energy is subject to significant costs, especially the cost of installing new infrastructure. However, with oil prices reaching new record highs above $145 a barrel of crude oil in July 2008, coal rising from $56 a ton in the beginning of 2008 to over $100 a ton by mid 2008, and with natural gas increasing from $7.71 a million British thermal units during winter 2007 to about $13 a unit for Winter 2008, alternative energy resources are becoming more appealing. Along with financial and environmental costs of fossil fuels, government pressure is driving PGN to look at clean and renewable energy. PGN plans to construct a new nuclear power plant, hoping to reduce its dependency on fossil fuels. Expenses for building a nuclear power plant can easily total $2B. If government approves PGNs application to build a new power plant, which takes three to four years, the new plant would not be in operation until 2018.
Both North Carolina and Florida are in the process of passing Renewable Energy Portfolio Standards (REPS). North Carolina will require public utilities to obtain 3 percent of their energy from renewable resources by 2012, and 12.5 percent by 2021. Florida legislature has yet to release a law enforcing REPS, but its governor has stated that utility companies will have to produce 20 percent of their electricity from renewable resources. These regulations will impact PGN both financially and materially since 99 percent of their electricity is generated from non-renewable resources. The required investments (spending) on renewable resources will be very costly. Increasing the production of alternative energy from 1 percent of total energy produced to over 10 percent is a big jump. Keeping up with government standards will be very costly since PGN will need to build new plants that will generate the amount of alternative energy required. Even though coal and natural gas prices have increased, their prices are lower relative to the expenses tied to renewable energy.
Both PEC and PEF are regulated by state governments imposing restrictions and requirements. There is no form of competition in the residential market, since the high cost of infrastructure installation as well as government regulation creates monopolies in different areas. The government regulates rates (to prevent price gouging) by authorizing a set return on equity for utility companies. PECs return on equity is 12.75 percent. PEF similarly has a base rate which it must use in order to calculate what it can and should charge its customers in order to optimize its earnings within the given restrictions. Investments done to fulfill government regulations can be costly, but are usually safe investments.
There are also government-imposed environmental requirements, such as the Clean Smokestacks Act, which are used to reduce pollution. PGN needs to modernize or build new infrastructure in order to continue operating and supplying the same amount of energy while decreasing the amount of greenhouse gases it contributes to the atmosphere. PEC has spent about $350M in the past three years, 2004 to 2007, related to the Clean Smokestacks Act. These expenses have increased operating costs, decreasing net earnings and cutting operating margins to 17 percent from 22 percent in 2003.
The residential market has decreased its demand for energy as fewer individuals are buying homes and, because of the credit crunch, many continue to lose them. The number of homes being built continues to drop; in August 2008 it fell 6.2%. PEFs revenue growth from residential customers has slowed down; in 2006 it saw an 18 percent increase while in 2007 it saw a humble 0.1 percent increase. During 2Q 2008, PGN obtained merely 2,000 new customers from Florida, a number below forecasts, compared to strong growth in the Carolinas where 25,000 new customers were added. PGN loses more customers as more houses are left vacant.
PGN has no retail competition since North Carolina, South Carolina, and Florida customers cannot choose their electricity providers. The larger the capacity of the company, the larger the region government will allow it to service making costly infrastructure safe investments. In a sense, utility companies are regional monopolies regulated by local and state governments. It does have competitors with its wholesale, commercial, and government customers. Its biggest competitor in North Carolina and South Carolina is Duke Energy which also provides electricity to these states. In Florida, its two biggest competitors are FPL Group and Southern Company which also sale electricity in Florida. For these customers, governments, companies or municipalities, the choice comes down to who provides energy for the lowest price.
|PGN||Duke Energy Corporation (DUK)||FPL Group (FPL)||Southern Company (SO)|
|Revenue ($ in M)||$9,153||$12,720||$15,263||$15,353|
|Net Income ($ in M)||$504||$1,500||$1,312||$1,734|
|MW Generation Capacity||21,000||28,000||37,500||40,870|