Duke Energy: Clean Energy, International Business To Drive Future Growth

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For the last few years, the biggest driver of revenue for Duke Energy (NYSE:DUK) has been its Regulated Utilities division. The company has two other business segments, namely International Energy and Commercial Power. Over the last three years, Duke has completed many power generation projects, resulting in significant revenue gains. The company has also started reporting the results of indirectly owned subsidiary Progress Energy in its income statements, leading to additional reported growth. Along with the increased retail pricing of electricity due to revised rates and a more streamlined cost structure, as a result of lower operational and maintenance costs in the Carolinas, these have been the most significant growth drivers for the company.

However, looking to the future, we can see two primary sources of growth for the company: 1) The International Energy Business and 2) Clean Energy Generation.  In our note below, we take a closer look at what factors will drive growth in both these areas.

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International Energy

Duke’s international energy business is viewed as one of the cornerstones of the company’s growth strategy given its access to the energy hungry Latin American market. The division, which operates in countries including Brazil, Peru, Argentina, and Chile, owns and operates electric generation capacity and also sells and markets electricity and natural gas. Although the business accounts for just about 8% of the company’s total sales, it is becoming increasingly important from a growth standpoint since over 85% of Duke’s revenues come from the regulated U.S. utility market, which is expected to witness relatively sluggish demand growth going forward. [1]

Electricity consumption in Latin America is still very low.  Annual per capita electricity consumption in Brazil stands at around 2,300  kilowatt-hour  (kWh) while it is around 3,300 kWh in Chile. [2] In comparison, the per capita consumption in the United States stands at around 11,900 kWh. This gives utilities and power generation companies a lot of room to grow in these markets. For instance, electricity consumption in Brazil is expected to grow at a rate of around 4.5% over the next decade and this would require the overall generation capacity in the country to grow by around 56% during the period. [3] In comparison, total load growth in the United States is expected to trend at just about 1% over the next few years.

Electricity rates  in many parts of Latin America are higher than those in the United States. For instance, retail rates in Brazil stand at over $0.12 per kWh while retail rates in Chile can approach as much as much as $0.25 per kWh. Although a part of these high prices could be attributed to higher transmission losses and generation costs, they are also due to high demand and relatively short supply. While Duke does not have retail operations in these countries, it should nevertheless be able to benefit at the wholesale level.

According to our estimates, Duke’s international business generates close to $77 per megawatt-hour (MWh), while the firm’s U.S. commercial power business, which also caters to the wholesale electricity market, realized only about $57 per MWh last year.

Clean Energy Generation

As regulatory authorities begin to exercise greater and greater scrutiny over conventional energy production methods, a number of energy companies are shifting their focus towards new and clean sources of energy generation. Duke has retired some of its old coal plants and is on track to achieve a roughly equal mix in energy production from coal, natural gas, and nuclear energy. Additionally, the company has outlined plans of returning to its old pipeline business by sharing interest in a $5 billion natural gas pipeline running from West Virginia to North Carolina. [4]

A shared interest in a mid-stream business gives the company two advantages: 1) it adds a revenue stream linked to the natural gas business, which is expected to be the predominant source of energy for commercial and residential requirements in the future, 2) being a midstream business, the company is protected from the volatility of the underlying prices of the commodity. Pipeline businesses generally engage in long-term contracts, whose value is only dependent on the demand for natural gas, and hence are affected only indirectly by the price of natural gas. In 2006, Duke Energy spun-off its natural gas business as Spectra Energy. However, the company gained a stable source of natural gas for its customers in Eastern North Carolina through its merger with Progress Energy. Now, the 550-mile pipeline will allow the company to reduce its dependence on coal for revenues even more. Currently, coal contributes around 40% to the energy mix.

Additionally, Duke is planning to build a 110 Megawatt wind power plant in Texas. [5] The addition of this project to the portfolio will take Duke’s wind power generation capacity to above 2,100 Megawatts by adding 910 Megawatts from 426 turbines scattered across 12,400 acres in the United States. The project is expected to boost the revenues of Duke’s Renewables business considerably.

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Notes:
  1. Duke Energy 10-Q []
  2. Index Mundi []
  3. The Wall Street Journal []
  4. Duke Energy, Piedmont Natural Gas select Dominion to build 550-mile ‘Atlantic Coast Pipeline’ to transport natural gas from West Virginia to eastern North Carolina []
  5. Duke Announces New Texas Wind Power Project, Smart Meters, September 2014 []