Duke Energy Corporation (DUK)

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Duke is one of the five largest electric utility companies in the United States, providing 28,000 megawatts of electricity to 3.9 million customers in North Carolina, South Carolina, Indiana, Ohio and Kentucky.^[1][2] - enough electricity to power over 20 million homes. Duke is unusual among electric utilities in that it produces only 1/3 of its electricity from coal. This effectively insulates it against increases in coal prices and means its power generation portfolio is more diverse than that of its peers.

[edit] Spin-Off of Spectra Energy

On January 2, 2007, Duke Energy completed a spin-off of its natural gas transmission and storage business named Spectra Energy (SE). Management hopes to unlock additional shareholder value by creating two pure-play businesses that operate in utilities and natural gas. With the newfound focus on electricity generation and distribution, Duke Energy will hopefully better serve the needs of their customers.

[edit] Business Financials

Duke has demonstrated steady financial performance over the past three years. Although revenue has steadily fallen, net income has increased marginally demonstrating the company's control over its costs.

^[3]

^[4]

In the utilities segment, analysts tend to look at EBIT (Earning before Interest and Tax) since it's a metric that looks at a company's profit before muddying it up with its complex finance and tax activities. Thus, since it nulls the effect of companies various financial structures and tax rates, EBIT provides an effective apples-to-apples comparison when analyzing two utility companies side-by-side.

[edit] Key Segments

[edit] U.S. Franchised Electric and Gas

U.S. Franchised Electric and Gas (now U.S. Franchised Electric post Spectra spin-off), operates in North Carolina, South Carolina, Indiana, Ohio and Kentucky.

[edit] Commercial Power

Owns and operates unregulated power plants primarily within the Midwest. Develops, owns and operates electric generation sources that serve large energy consumers, municipalities, utilities and industrial facilities.

[edit] Duke Energy International

Operations are located in Central and South America with approximately 4,000 MW of generation, primarily hydroelectric, in six countries: Argentina, Brazil, Ecuador, El Salvador, Guatemala and Peru.

[edit] Crescent Resources

Crescent Resources manages land holdings and develops high‑quality commercial, residential and multi‑family real estate projects.

[edit] Key Trends/Forces

[edit] Rising Fossil Fuel Prices

Prices for fossil fuels, the key energy input for many of Duke’s electrical generation plants, have risen steadily over the past few years with the price of oil approximately quadrupling since the year 2000.^[5] The booming overseas growth from industrializing counties such as China and India have pushed fossil fuel demand and prices new to new heights. To hedge against a sustained high energy price environment, Duke Energy, other utility companies and the government, have been forced to look at alternate means of energy production which are cost effective and clean. Duke which only produces 1/3rd of its energy from coal, is already well below the industry average in its use of fossil fuels.

[edit] Nuclear Power & Electricity Generation

^[6]

The key difference between nuclear and fossil plants is the cost structure. Nuclear plants require very large capital investments (to construct the plant) but little expenditure for fuel because it takes relatively little uranium to power a plant. On the other hand, fossil fuel plants require relatively little capital investment but have high fuel costs because they require large amounts of coal, oil or gas. In the past, low fossil fuel prices gave given fossil fuel plants a cost advantage over nuclear plants. The cost advantage, compounded by the stigmas of nuclear energy (the not in my backyard phenomenon) has prevented new nuclear construction for almost 30 years.^[7] Record fossil fuel prices have begun to reverse this trend. The possibility and implications of peak oil may reinforce this reversal. Already, nuclear utilities such as Duke Energy, Exelon and Entergy have begun filing for permits for construction of new nuclear plants. On December 13, 2007, Duke Energy submitted a new nuclear license to application to the U.S. Nuclear Regulatory Commission to construct a two-unit nuclear power plant in South Carolina.

Of course, it is critical to remember that a substantial portion of Duke Energy's business remains vulnerable to rising energy prices and could see a negative impact on earnings if fossil fuel prices continue to rise.

In all, the legislative environment is favorable for Duke Energy. Increasing concern over global warming makes US carbon emission legislation likely in the short to midterm. Because a significant portion of Duke's portfolio is in nuclear energy (47% of Duke Energy power generated is from nuclear - 2002)^[8] any legislation based on carbon trading markets will allow Duke to offset emissions at its carbon based plants with carbon credits from its renewable and nuclear plants. Additionally, the 2005 federal energy bill provided many government incentives for the continued expansion of the US nuclear fleet.

[edit] Global Warming and Environmentalism

Over the past few years, global warming has moved from the fringes to become one of the single greatest single challenges facing the world today. A growing body of scientific evidence ties carbon dioxide emissions to rising temperatures. As a result of growing popular awareness of the risks of global warming, many large corporations have stepped up their efforts to project greener images. Additionally, many expect the U.S. government to enact more stringent legislation limiting carbon emissions. Environmental awareness is another key trend driving the renaissance of nuclear energy. Compared to their fossil fuel peers, nuclear energy plants have negligible emissions. Duke operates a number of hydroelectric, alternative and renewable energy plants. The company recently began to push for higher efficiency standards and other environmentally friendly state policies in the areas it operates, probably hoping that a paradigm shift will facilitate a shift towards renewable energy, ultimately benefiting the company.

[edit] Weather

Weather can have a material impact on Duke's business. Warmer than expected winters can lead to lower demand for heating energy, whereas a cooler than expected summer can lead to lower energy demand for cooling.

According to Duke's 2006 annual report, unseasonably warmer weather leader to lower revenue generation due to a decrease in demand for heating. The exact figures are as followed:

• A $32MM decrease in electricity sales to customers due to unfavorable weather conditions compared to the same period in 2005.^[9]
• Weather statistics in 2006 for heating days were approx. 9% below normal as compared to 2% above normal in 2005.^[10]
• Overall weather statistics for both heating and cooling periods were unfavorable for revenue generation compared to the same periods in 2005^[11]

[edit] Government Regulation and Legislation

The U.S. government plays a critical role in the financial performance of the highly regulated energy sector since the government sets the price of electricity. Each of Duke's utility businesses faces a variety of challenges and potential benefits that may arise from changes in legislation and regulatory schemes.

[edit] Recent Regulatory News

• Kentucky - Rate increase in Kentucky took effect 1/07 partially due to rising fuel costs. Although rates are now 20% higher, customers still pay a lower rate than most in the state.^[12]
• Nuclear Fuel Storage - Department of Justice (DOJ) has awarded the company $56MM for costs associated with nuclear fuel that the DOJ had previously agreed to remove dating back to 1998 ^[13]

[edit] Competition

[edit] References

1. ↑ DUK's Energy Business Segments
2. ↑ DUK's Energy Business Segments
3. ↑ DUK's Energy Business Segments
4. ↑ DUK's Energy Business Segments
5. ↑ NYTimes (9/13/07) - Crude Oil Price Closes above $80
6. ↑ Electricity Sources: NEI Report
7. ↑ Scientific American (9/26/07) - Nuclear Power Reborn
8. ↑ DUK's 2006 10-K (Page 10)
9. ↑ NYTimes DUK's 2006 10-K (Page 45)
10. ↑ NYTimes DUK's 2006 10-K (Page 45)
11. ↑ NYTimes DUK's 2006 10-K (Page 45)
12. ↑ Duke Energy Kentucky Rate Increase
13. ↑ Duke Energy Nuclear Suit
14. ↑ AYE's 2006 10-k (Pg 52)
15. ↑ AEP's 2006 10-k (Pg A-45)
16. ↑ DUK's 2006 10-k (Pg 40)
17. ↑ AYE - About Us
18. ↑ AEP's Investor Page)
19. ↑ DUK's Energy Business Segments
20. ↑ AYE's About Us
21. ↑ AEP's Investor Page)
22. ↑ DUK's Energy Business Segments
23. ↑ AEP's 2006 Annual Report (Item 2)
24. ↑ DUK's 2006 10-k (Pg 11)
25. ↑ AYE's 2006 10-k (Pg 52)
26. ↑ AEP's 2006 10-k (Pg A-45)
27. ↑ DUK's 2006 10-k (Pg 40)