BGE parent's profits fall 26%

Power prices trailed cost of natural gas

May 01, 2008|By Paul Adams | Paul Adams,SUN REPORTER

The same unpredictable power markets and soaring fuel prices that have frustrated utility customers contributed to a 26 percent decline in first-quarter profit for Constellation Energy Group, the company reported yesterday.

Though still highly profitable, Constellation said it suffered when power prices didn't keep pace with the rising price of natural gas - a critical factor in the price of electricity.

That rare disconnect in energy markets was good for electricity buyers, who were spared even higher power prices - at least for now. But it was bad for Constellation, which said the anomaly contributed to multimillion-dollar losses in a segment of its business that buys and sells energy in competitive markets.

And soaring coal prices - another big factor in electricity prices - also worked against the company last quarter when two of its suppliers couldn't deliver on promised production, forcing Constellation to write down the value of its supply contracts with key customers by about $68 million.

In the scheme of things, the setbacks amount to little more than a bad day for a company with $21 billion in annual sales. The rest of its business is humming, and the Baltimore-based energy conglomerate said it made a first-quarter profit of $145.7 million. The company said it still expects to meet its earnings projections for the year.

But for consumers facing higher utility bills, the fact that Constellation saw lower results at a time of rising energy prices provides a glimpse into the complexity of a global energy business few in Maryland understand.

"This is not your grandfather's utility," said Paul Patterson, an analyst with Glenrock Associates in New York. "This is a company involved in very dynamic and volatile and complex commodity markets."

The simple-to-understand part of Constellation's business - the part that makes electricity and sells it - is performing well. Profit from its generation fleet - made up mostly of its Maryland power plants - grew 12 cents a share for the quarter as the company benefited from higher energy prices in Maryland and elsewhere.

But it's the part of Constellation that trades in electricity, natural gas, coal and other energy products all over the world that carries the biggest potential for risk. Part of that business takes large positions in electricity markets, placing bets on where prices will go. When the market behaves normally, the company can squeeze sizable profits from the operation. But when things go awry, millions of dollars can hang in the balance.

That's partly what happened in the first quarter, when the company placed bets on the historically valid assumption that electricity costs would rise in proportion to prices for natural gas. Instead, electricity prices remained stable compared with the 24 percent increase in natural gas during that time. Some have suggested that the disconnect is the work of financial players - such as banks or hedge funds - that have recently liquidated their energy holdings to raise cash.

"We can't explain it, and we don't think it's reflective of fundamentals in the market," said Tom Brooks, Constellation's executive vice president, on a conference call with analysts.

Some analysts say the company simply got squeezed in a volatile market.

"They take trading positions which were not, obviously, backed by physical sales of their power, and those trades clearly didn't work out," said Paul Fremont, an analyst with Jefferies & Co. in New York.

Constellation executives said the distortion in the market is probably temporary. That's not good news for utility customers, because it means electricity prices will likely rise even more.

"Fuel inputs really rose a lot faster than the power price, and whether that's likely to be sustainable seems unlikely," said Mayo A. Shattuck III, Constellation's chief executive.

Coal, which fires three of Constellation's Maryland power plants, is another reason for concern. The commodity climbed 50 percent during the first quarter, further stressing electricity markets. When Maryland deregulated the electricity industry in 1999, Constellation could buy coal for about $22 per ton. Today, that price is closer to $90, Shattuck said.

"It gives you a more vivid understanding of why bills are going up by 8 percent," he said, referring to this year's BGE rate increases.

The rise in coal prices was a blessing and curse for Constellation in the first quarter.

As a major global supplier of coal to utilities and other buyers, Constellation was able to profit from contracts it had in place before prices rose. But two of its suppliers in the Appalachian region became insolvent after they couldn't make promised deliveries because of production problems. Constellation will have to absorb the losses associated with buying more expensive coal elsewhere in the market.

Its shares jumped yesterday in early trading but ended the day down $1.66, at $84.65 a share. Its earnings amounted to 81 cents a share, compared with $1.07 a share in the year-earlier quarter. Earnings for BGE, the company's utility subsidiary, grew 1 cent per share to 41 cents as it recorded higher profits from transporting electricity over its high-voltage power lines and lower costs from storms.

"I think the volatility in the marketplace proved somewhat challenging," said Patterson, the Glenrock analyst, referring to the quarter. "But they appear to have navigated it."

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