Morningstar | Texas Grid Operator Sees Widening Supply/Demand Cushion; Bearish for Generators
We are reaffirming our $32 fair value estimate for NRG Energy and $20.50 fair value estimate for Vistra Energy after the Texas electric grid operator, ERCOT, released its updated 2019 summer reliability report and long-term supply and demand outlook. We are reaffirming our no-moat, stable trend rating for NRG and no-moat, negative trend rating for Vistra.The supply/demand balance in Texas power markets remains tight, but ERCOT's outlook suggests conditions have eased since its previous forecasts. This is bearish for NRG and Vistra, each of which gets about one third of its EBITDA from its Texas generation fleet. We consider each stock about 20% overvalued as of May 8.
We continue to expect Texas supply/demand conditions to ease as new generation, especially wind and solar, outpaces demand growth. ERCOT raised its 2019 summer supply resource estimate 1% from its March assessment and now projects an 8.6% reserve margin, up from 7.4%. ERCOT also raised its 2021-23 forecast reserve margins from  its last report in December due to projected supply growth.
We expect Texas forward power prices will remain backwardated after the bearish reports, making it difficult for NRG and Vistra to hedge future generation without locking in lower earnings. Both companies face flat or lower EBITDA in 2020-21 based on current power market prices.
However, both companies maintain bullish positions with only about half of their expected Texas generation hedged for 2020. Reserve margins remain tight enough that a heat wave could cause real-time and forward power prices to jump, offering attractive hedging opportunities. NRG and Vistra last year hedged substantially all of their expected generation for this summer, effectively locking in 2019 earnings.
We continue to believe each company will try to expand its retail businesses to offset lower generation margins in 2020-21. Tight reserve margins and higher prices would help generation margins but probably hurt retail supply margins.
Vistra Energy operates an integrated retail and generation business in markets throughout the U.S. Through its subsidiaries, the company is engaged in electricity market activities, including electricity generation, wholesale energy sales and purchases, commodity risk management and retail sales of electricity. The company has six segments: Retail, ERCOT, PJM, NY/NE (comprising NYISO and ISO-NE), MISO and Asset Closure. The Retail segment is engaged in retail sales of electricity and related services. The ERCOT, PJM, NY/NE and MISO segments are engaged in electricity generation, among others. The Asset Closure segment is engaged in the decommissioning and reclamation of retired plants and mines.
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