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Morningstar | Texas Summer Gives NRG Brief Opportunity for Upside; Long-Term Outlook Still Bearish

We are raising our fair value estimate for NRG Energy to $25 per share from $23 after updating our expectations for NRG's incremental hedges for 2019-beyond, particularly in Texas. This revision anticipates updates we expect NRG management will provide when they announce second-quarter earnings on Aug. 2. Our near-term outlook assumes NRG took advantage of high power prices this spring and midsummer.

Even with the uplift in our near-term outlook, we continue to think the market is extrapolating abnormally high Texas power prices too far into the future. The market's excitement about forecasts for a hot 2018 summer and tight reserve margins in Texas, NRG's core market, lifted power prices and NRG's stock to a 52-week high in mid-May. But those expectations for extreme supply-demand conditions have moderated.

The Texas grid has easily balanced supply and demand this summer even with increased oil and gas industrial demand and a hotter-than-normal June and July. Morningstar's commodity and energy group thinks Texas could set peak demand records with cooling degree days trending 15%-20% above normal. The key factor depressing prices is higher-than-expected wind generation, in line with our long-term thesis. Wind generation this summer has been nearly double the level that the Texas grid operator used in its initial summer assessment.

But power prices, which drive NRG's earnings, remain volatile, as we expected. This month, the critical August on-peak contract in Texas has traded between $105 per megawatt-hour and $175/MWh, demonstrating the danger of extrapolating near-term power prices into the future.

Power prices have rebounded on forecasts for extreme heat in the coming weeks. This gives us greater confidence that NRG will be able to add hedges for 2019 and beyond that are above forward power prices since we last updated our forecasts.

For more information on our NRG Energy thesis and outlook for Texas power prices, please see our piece "When Texas Hype Cools, NRG Energy Will Power Down" published June 2018.