Only a handful of utilities in southern and southwestern U.S. states are “likely” to avoid the adverse effects on natural gas demand that the coming El Nino is expected to produce this winter, according to a new report by Williams Capital.

Following a comprehensive review of past El Nino events and weather analysis, analysts believe the expected warmer temperatures could slightly impact fourth quarter earnings, but going into the first quarter of 2003, earnings for power and natural gas utilities, pipelines and marketers could see earnings “severely” impacted.

According to the 16-page report by Christopher Ellinghaus and Ida Fiumefreddo, the National Oceanographic and Atmospheric Administration (NOAA) expects an El Nino this winter, even though so far “one could not tell by the weather.” El Nino would bring warmer-than-normal winter temperatures to the Northeast, Midwest, northern Rockies and Pacific Northwest.

“We do not believe that management guidance or Street estimates, for nearly two-thirds of the [power and natural gas] universe, reflect the potential havoc El Nino could play on earnings in 2003,” said the analysts. “Lower potential earnings would affect liquidity and cash flow in an already constrained environment,” and “extreme uncertainty” in 2003 earnings could lead some stocks to “react badly to the additional strain of earnings further reduced by El Nino.”

The Williams Capital analysts believe that the media has not yet “capitalized” on the anxiety that El Nino produces, noting that the cold Northeast temperatures make it “hard to imagine that the U.S. is likely in for an abnormally warm winter. Yet, another El Nino event is on the way and most people are not yet aware of the developing surprise.” NOAA, they said, has been tracking El Nino’s development since last spring and is “warning” that the system is strengthening.

Now considered unlikely to match the El Nino of 1997-1998, NOAA has described the current El Nino as moderate but gaining strength. It also has been “very unpredictable” in the past, the analysts said. “Only one fact is certain…the vast majority of scientific and government authorities are expecting a significant weather disturbance this winter in the United States.”

El Nino’s primary influence, they said, is on surface temperatures. In this case, NOAA is forecasting warmer-than-normal temperatures throughout the Pacific Northwest, Plains, Midwest and Northeast. The middle continent is expected to have normal temperatures, while portions of the deep South, including parts of Texas, Louisiana, Mississippi, Alabama, Georgia, South Carolina and Florida, will have normal to below-normal temperatures.

Also affected by El Nino are precipitation patterns. The NOAA is forecasting that parts of the Pacific Northwest, including parts of Washington, Oregon, Idaho, Wyoming and Montana, and most of the Rust Belt states in the Midwest will have below-normal precipitation. The deep South, southern California, southern Nevada, New Mexico, Arizona, Oklahoma, Texas and parts of Arkansas, Missouri, Nebraska and Kansas will have “abnormally” high precipitation. The rest of the states are forecasted to have normal precipitation, with below normal trends in Hawaii.

“Unfortunately, most of the effects of El Ninos [in the past] have a deleterious impact on energy company earnings,” said the Williams Capital analysts. “The effects of the previous El Nino were felt from the fourth quarter of 1997 through the fourth quarter of 1998. The first and fourth quarter earnings for electric utilities can be significantly reduced, particularly in the northern states.”

Those expected to be “punished” by the warmer weather will be natural gas utilities and pipelines in the largest domestic gas consuming regions. In the first quarter of 1998, analysts noted that natural gas consumption by residential consumers declined over 15%; many electric and gas utilities showed an average decline in year-to-year earnings per share of 6-7%. Gas local distribution companies also experienced a 7-8% average decline. Utilities also showed 10-20% declines in operating earnings.

However, the cooler southern temperatures gave gas and electric utilities in those regions an average increase in earnings for the first quarter of 1998 of about 7% over the previous year’s first quarter.

Although they believe it is “safe to assume” that this El Nino will not be as significant as the last one, “the anecdotal evidence certainly suggests to us that El Nino has arrived,” said Ellinghaus and Fiumefreddo. “The potential storm damage, lower energy demand and lower commodity prices likely associated with the current El Nino should have an adverse effect on energy company earnings that are incremental to the issues currently plaguing the sector. The likelihood of negative comparisons at this time of extreme earnings uncertainty for our distressed sector is unfortunate.”

In 1998, said the analysts, “utilities had advance warning El Nino was coming and far more capacity to manage earnings than they do today,” adding, “we fear that negative surprises await.”

The report assumes that heating degree days this winter will be down 5-10% from the norm. Natural gas consumption “is very difficult to forecast…but we suggest that gas demand could fall two [to]three times the decline in heating degree days, or perhaps 15-30% if the El Nino’s effects prove moderate.”

On natural gas prices, the analysts expect a “late winter drop” to $3.50/Mcf or less as the full effects of El Nino’s warming materialize. However, as the economy “presumably recovers” next year, prices will rebound.

For electricity prices, there will be a “commensurate” decline with the gas price fall, “at least temporarily.” Also, the higher temperatures in some northern states “should also produce a decrease in electricity demand in some regions” like the Pacific Northwest, where electricity is used for heating.

Finally, the U.S. energy infrastructure also is likely to see adverse effects from El Nino, said the analysts, with storm surges, mudslides and flooding in California and the Gulf states affecting transmission and distribution assets.

“Unfortunately,” they said, “very few electric utilities, natural gas distributors, energy marketers or natural gas pipelines will likely escape unscathed from the developing El Nino.” The “only conceivable beneficiaries” will be power and gas utilities in the South, Gulf Coast and Southwest.

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