Duke Energy’s (NYSE:DUK) commercial power business manages and operates power plants and is engaged in wholesale electricity marketing and procurement of electric power. The division also holds the company’s renewable energy subsidiary and a retail subsidiary, which caters to customers in some parts of Ohio. In this article, we will take a brief look at the firm’s commercial business, the wholesale electricity market that it operates in and also the role of renewable energy in Duke’s electricity generation mix.
Wholesale Electricity Market
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Unlike the retail market where electricity is sold directly to end consumers, wholesale power is sold to other parties such as large consumers or retailers who in turn supply to end consumers. Electricity prices in the retail market are relatively stable since utility companies often have a monopoly in the regions that they operate in and the rates are regulated by the government. Utility companies need to file rate cases with state regulators when they seek to raise retail rates. The wholesale market, on the other hand, is open to a much broader set of participants including suppliers and marketers attached to utility companies, independent power producers who generate their own electricity as well as traders who buy and sell electricity.  Wholesale electricity prices vary with supply and demand and the price fluctuations may be very wide at times. While there are various pricing methodologies, the spot prices in wholesale electricity markets are usually set by the regional transmission organization (RTO) through a uniform auction process where the various power producers place bids before their power is dispatched, beginning from the lowest bidder to the highest. ((How Wholesale Electrcity Prices Are Set, EPSA)) The key differentiating factors between different wholesale power producers include pricing, availability of capacity as well as their reliability of service.
Duke’s Commercial Operations
Duke’s commercial power business primarily operates out of the Mid-West through the PJM Interconnection regional transmission organization and accounts for about 10% of the company’s total sales. The division’s margins are lower and more volatile when compared to the firm’s U.S. franchised electric and gas (USFE&G) division given the variability in pricing. According to our estimates, the commercial power business had an adjusted EBITDA of around 20% in FY2012 versus an EBITDA of above 30% for the USFE&G division. The division has around 6,800 MW of generation assets with a mix of coal-fired power plants as well as combined cycle and peaking natural gas-fired units. While the natural gas assets have been performing reasonably well due to low gas prices as well as a proximity of the assets to the Marcellus Shale, the coal assets have seen their margins being squeezed in recent times partly by low gas prices and stricter mercury emission norms. While Duke has hedges for its commercial generation assets, it has been facing some pricing pressures due to low capacity revenues on the PJM interconnection in recent times. 
Renewables Represent A Sliver Of Duke’s Generation Mix But They Could Play A Growing Role
Duke has also been gradually expanding its renewable energy portfolio and holds close to 1,300 MW of solar and wind power assets. Most of the power generated by Duke’s renewables projects is sold through long-term power purchase agreements, which allow for more stable revenues. Although renewables currently account for a very small part Duke’s overall generation capacity, we believe that their share is likely to increase going forward as renewable generation assets becomes more economical and also as government regulations require utility companies to derive an greater portion of their electricity from renewables through regulations such as the renewable portfolio standards.
Additionally, there is a possibility that the government will develop market-based instruments and performance standards, which could allow for trading of emission credits.  For instance, a utility company may continue to generate electricity from a coal-fired power plant that has CO2 emissions above stipulated norms by offsetting these higher emissions through credits that it receives from a solar or wind power farm that it owns. Duke operates a significant number of coal-fired power plants that are facing increasingly stringent regulations relating to carbon dioxide and air toxins and such incentives could increase the company’s focus on renewables.
We have a price estimate of around $73 for Duke Energy, which is about 10% ahead of the current market price.Notes: