The outlook for the natural gas and power industry bears a strong resemblance to the markets in the early 1990s, according to a report issued by Credit Suisse First Boston Equity Research last week. The key difference is the current valuation for the Standard & Poor’s 500 Index is 10% higher than it was in 1992, while the valuation for the natural gas and power sector is 30% lower, it said.

“…Our outlook is a future looking like the early ’90s,” which saw the “Columbia Gas bankruptcy, commodity prices spiking before falling, regulation supporting the industry (to avoid other bankruptcies), and capital tilting toward unregulated assets,” Credit Suisse energy analyst Curt Launer said in the report. “Some of the similarities are a stretch, but the overall trends are undeniable in terms of a return to the roots of the industry and resetting the bar of growth to [a more conservative] 5-10% and total return to 10-15%.” Credit Suisse’s analogy falls short in one area: the current shift in the industry appears to be toward regulated assets, and away from the unregulated operations that were once popular.

In a semi-annual thesis report to be released this week, Credit Suisse will predict that the industry “dislocations” in the wake of Enron Corp.’s accounting scandal and collapse, “while much more severe than anticipated, [are] nearing an end,” it said. “Commodities are expected to remain strong. Better balance sheets and restructurings suggest more stability ahead.” Credit Suisse’s prognosis is completely at odds with that of Standard & Poor’s, which predicted in its own report last week that rough times would continue for traders and other companies until at least 2003, with some companies falling into bankruptcy along the way.

S&P painted a bleak credit picture for companies in a separate report addressing the “two defining events” that rocked the energy industry over the past year — Sept. 11 and Enron. “Credit quality in the utilities and competitive energy sector is likely to remain under pressure for the remainder of the year and probably well into next year,” wrote energy analyst Ronald M. Barone and others in the report. This is due to the “heightened focus on the sector” by federal investigators and the “very large regional reserve margins” due to the high level of power plant construction over the past two years, they said. Despite these pressures, “the sector is not expected to fall off a credit cliff,” said William Chew, S&P’s Utilities Sector managing director.

Noting that pipelines still are hard assets generating “significant excess cash flows,” the Credit Suisse analysts said they “envision another period of merger and acquisition activity” ahead, with both new and traditional partners involved. “With pipelines earning 13-15% returns…we still regard them as good businesses. We expect several new owners to emerge as ‘pipeline companies’ based on the asset sales being done or contemplated by Williams, Enron, El Paso and others. Ultimately, we look for these new entities, as well as the restructured ‘old ones,’ to develop the benefits of excess cash flows and diversify into non-pipeline assets again.”

They noted they expect El Paso to “benefit” as a result of Enron’s decision to put its 50% share in Citrus Corp. — operator of Florida Gas Transmission — up for sale. El Paso, which owns the other half of Citrus, has the “right of first refusal” to buy Enron’s interest in the company, they said. In addition, published news accounts indicate El Paso plans to divest itself of its “Project Electron” unit, the report noted. “We value the 4,400 MW owned by ‘Electron’ at about $400 million net of debt.”

Contrary to S&P, the Credit Suisse report anticipates a recovery in the merchant sector’s earnings before interest and taxes (EBIT), but it noted that future trading operations will be significantly smaller. “Our initial analysis of these functions suggests that the ‘new merchants’ will be about 25% of the size of the previous entities,” it said. As companies race to either downsize or exit their trading operations, S&P credit analyst Todd Shipman said “some of these companies may be subject to cash calls if they experience further deterioration.”

Looking to the future, “the ‘add-ons’ of [exploration and production assets], some merchant exposure and well-run pipelines, power generation and electric utility operations make for combinations and strategies that look to be long-term winners,” according to the Credit Suisse report.

Credit Suisse’s recommended stocks in the utilities sector include UGI Group, PG&E Corp., Allegheny Energy, El Paso and Dominion Resources. “Recent strong generation output data suggests that the regulated electric utility operations are on track to show positive year-over-year comparisons. In addition, valuations are not unreasonable, with earnings multiples at five-year averages (about 12 times) and dividend yields at a relatively stable 5%.”

While the Enron bankruptcy has proven to be a “more significant event” for the energy industry over the past year, the Sept. 11 attacks have taken their toll on companies as well, according to an S&P report. Since the attacks, several power and energy companies “[have] found themselves in the same boat — caught in a wave of policy cancellations by insurance and reinsurance firms.”

Insurance coverage for power companies, which use specialty markets, costs anywhere from 1% to 10% of the policy limits they cover, according to the report. Some larger insurance companies continue to offer coverage, but with caps or thresholds, while many insurers have added terrorism exclusions clauses to their policies, it noted. “As policies come up for renewable, some high-profile projects may even find insurance commercially unavailable,” said S&P credit analyst Peter Rigby.

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