Taking advantage of the energy crisis gripping the southwestern U.S.,
The Vancouver-based major generates power at its wholly owned Waneta hydroelectric dam and supplies electricity to the Trail metallurgical complex and Sullivan mine. Constructed in 1954, the dam sits 10 km south of Trail on the Pend Oreille River, close to the U.S. border. The company also owns a 15-km direct transmission line to the U.S. power distribution grid, the only company in British Columbia to do so. Canaccord Capital analyst Greg Barnes, who continues to rate Cominco a buy with a target price of $31.50, says the company is in a unique position to benefit from the abnormally high power rates in the Pacific Northwest.
The operation of the Waneta dam and the supply of power from the dam are governed by a contractual agreement between Cominco and BC Hydro. The Waneta dam is one of six hydroelectric generating plants in the area. Under the Canal Plant agreement, BC Hydro manages the daily co-ordination of the six facilities.
Cominco is entitled to receive 2,500 gigawatt hours (GWh) of electricity annually, even during low-water years. Barnes says this contract was re-negotiated several years ago and has been extended to 2035.
“Cominco will continue to receive its power entitlement, even if water flows in the area are below normal,” states Barnes, acknowledging that there is no force majeure clause in the contract. There have been concerns that a lower-than-normal snowpack in British Columbia will result in lower water levels.
Last year, the major’s smelting and mining operation consumed close to 1,800 GWh. The surplus, about 687 GWh, was sold into the spot market. By comparison, surplus power sales in 1999 were 674 GWh. Cominco sells its power through BC Hydro’s export subsidiary.
Cominco reported $163 million in revenue from power sales in 2000, versus $25 million in 1999, which Barnes considers a normal year. The company received an average price of US$159 per megawatt hour (MWh), compared with US$24 per MWh in 1999. During the fourth quarter, power sales averaged US$271 per MWh.
Net earnings in 2000 were $170 million (or $1.99 per share), twice the level of 1999 before special items and the highest in the past decade. Trail generated an operating profit of $224 million in 2000, a $153-million increase over 1999. Power operations accounted for $137 million of the Trail profit.
In the spring and summer of 2000, unprecedented demands for electricity, coupled with shortages in generation capacity in the U.S. (particularly California), led to significant increases in wholesale power prices. Cominco began supplementing its revenues from surplus power sales by selectively reducing zinc production at peak power-demand periods, thereby freeing up electricity for sale.
In December of last year, Cominco took advantage of soaring U.S. spot electricity prices and sold $132 million worth of electricity to a U.S. energy company. This involved cutting production at Trail by almost half from mid-December 2000 to late January 2001. Cominco reduced production by 20,000 tonnes and purchased zinc on the market to maintain customer commitments.
The company’s biggest challenge in 2001 is to increase the profitability of Trail through the combination of power and metal sales.
Cominco’s cutbacks in the first nine months of this year are expected to total 92,000 tonnes of zinc production, equal to 32% of planned zinc output. The cuts are designed to free up an extra 370 GWh of power available for sale, on top of the normal base of 650 GWh. Production curtailments include 24,000 tonnes in the first quarter, 20,000 tonnes in the second quarter and a full shutdown of 48,000 tonnes in August and September.
The company has arranged to sell enough power to ensure Trail maintains a normal profit level (about 25%, according to Haywood Securities) during the shutdown period, leaving another 750 GWh to sell over the next six months.
At current spot prices of US$350 per MWh, Haywood estimates that the sale of 750 GWh could generate an incremental US$250 million in power sales. Haywood continues to recommend Cominco shares as a buy.
According to Barnes, forward prices for the third quarter of 2001 are currently in the US$450 MWh range, with year-to-date prices averaging US$287 MWh. “If Cominco realizes prices at these levels for its power sales later this year, we expect that our earnings per share and cash flow per share could move materially higher.”
Barnes’ revised 2001 earnings estimates for Cominco of $2.85 per share and $5.27 cash flow per share do not include the additional power sales that will occur in August and September.
“We recognize that investors are unlikely to place high multiples on earnings and cash flow from power sales, which are unpredictable and undoubtedly unsustainable,” says Barnes. “But the potential that Cominco could pay a special dividend, initiate a share repurchase program, and/or lower debt should be recognized. We believe the market has yet to perceive the full magnitude of the impact that power sales could have in 2001, and potentially in 2002, on Cominco’s earnings and cash flow.”
Haywood Securities has maintained, for some time, that the electricity crisis in California will only get worse as we move into the high-load summer months. “We do not expect that a power problem that has been stewing for five to ten years will get resolved in 2001, and we therefore expect surplus power sales by Cominco at high prices will continue in 2002 and 2003,” the firm states in a recent market report.
In addition, the closing of the Sullivan mine in southeastern British Columbia, planned for December 2001, will free up another 150 GWh of surplus power for sale into the U.S. market.
“At current zinc prices, Cominco will have nominal earnings from its zinc business but should have substantial earnings from the power sales,” states Haywood. The company will report its first-quarter results on April 24.
Cominco is trading around $29.30-28.50 in a 52-week range of $32-17.25. The company has 85.6 million shares outstanding, with
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