Bonds of natural gas and power suppliers accused of overcharging California's utilities were trading at or close to their wides for the year last week, and fixed-income energy pros say they are well oversold. Enron,El Paso Natural Gas,Calpine and Williams are among several companies from which the state wants a combined $8.9 billion. The Federal Energy Regulatory Commission (FERC) is currently considering the state's allegations.
Enron (Baa1/BBB+) 6.4% of '06 notes were trading at 165 basis points over Treasuries last week, out from 155 over on May 28. Dynegy (Baa2/BBB+) 6.87 of '11 notes were at 190 last week, out from 180 on May 28, and Calpine 8.5s of '11 were at 356 over last week, compared to 309 on May 11. Energy and utility analysts attribute the spread widening to the companies' California exposure, and say they will eventually come back in.
"I think it's developing into a really big buying opportunity for long-term buyers," says Ted Izatt, energy analyst at Lehman Brothers. He says that it is difficult to predict the outcome of legal and regulatory actions, and that further litigation is the big risk that investors need to keep in mind. Still, he says the companies have broad and diverse operations, and believes that in most cases the bonds will eventually return to where they were earlier this year. He notes that bonds of energy companies not involved in the FERC case, such as Occidental Petroleum, trade well inside those that are. Occidental's 8.45% notes of '29 were trading at 168 basis points over Treasuries last week, significantly tighter than the Williams 7.5s of '31, which were at 225, even though the Occidental paper (Baa3/BBB-) has a lower rating than the Williams (Baa2/BBB-). He says Williams is one of his top recommendations among the companies he covers.
Austin Ramzy, buyside analyst at Principal Capital in Des Moines, says his firm has been buying bonds of power suppliers on weakness. He says El Paso's exposure to California represents easily under 10% of the company's total business, and even a negative outcome in negotiations with the FERC would not drive the firm into bankruptcy. He says El Paso (Baa2/BBB) 7s of '11 were 145 to 150 basis points over Treasuries a month ago, and traded as wide as 215 over before coming in a bit to the 180-190 range last week.
Paul Tice, energy analyst atDeutsche Bank Securities, notes that El Paso is separately accused of manipulating the natural gas market in California through their merchant energy affiliate. Nonetheless, he continues to recommend the paper along with the other gas pipeline companies, as he doesn't see a significant settlement coming out of the case. "You can't hold El Paso responsible for all the infrastructure bottlenecks within the gas pipeline system in California," he says.