The Fredonia Reactor — Could it Hand You Profits of 1,099%?

By StockGumshoe ⋅ January 6, 2010
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If you’ve been swabbing the decks on the good ship Gumshoe for more than a few weeks, you probably know that I’m a sucker for a good made-up name — so I couldn’t very well resist writing about the Oxford Club’s Fredonia Reactor, could I?

Now, if the letter had been signed Rufus T. Firefly and asked us all to pledge allegiance to Freedonia, I’d have been utterly powerless and would have written about it on the first day, vacation be damned — but now we’re a few days into this big marketing push and I’m eager to dig in, Groucho or no.

And to make it even nicer, they made up another name, too — the Fredonia reactor will be the most tremendous power plant in the world, we’re told, but it’s owned by a company that they’ve nicknamed “Smart Electric Co.” Here’s the P.S., which is almost always the best part of a sales letter:

“The ‘Smart Electric Co.’ is in the early stages of ‘firing up’ a massive new ‘power plant’ 62 times stronger than a nuclear reactor. And the government just handed them the opportunity to generate up to $6.8 billion a year by connecting the Fredonia Reactor to major U.S. cities. This event could send plays on Smart Electric soaring 1,099% or more. I urge you to act on this information quickly. Once the mainstream media picks up on this story, the big gains will be long gone.”

And hopefully you’ve noticed, my good Gumshoe students, that “fired up” and “power plant” are also in quotes — there’s a good reason for that. Let’s dredge some more clues from the morass, shall we?

“Cheaper Than Oil… Stronger Than Nuclear… Cleaner Than Hydro… It’s 62 times stronger than a nuclear power plant… But releases zero emissions…”

Sounds like magic, no? There’s more …

“Imagine a power plant so huge it covers more than 100 square miles…

“With capacity 62 times stronger than a modern nuclear reactor…

“One powerful enough to light up 49 million American homes across the Midwest… Or run 217,000 football stadiums continuously for a year.

“That would easily make it the strongest power plant on Earth.

“It would dwarf the world’s current number one. The enormous Three Gorges Hydroelectric Dam in China generates 18.2 gigawatts of electricity.

“This power plant would triple that.

“Perhaps more amazing, this plant won’t depend on traditional fossil fuels.

“It runs on what the International Energy Agency calls ‘the most advanced of the ‘new’ renewable energy technologies.’”

So that’s what they call the “Fredonia Reactor” — what is it? Well, the reason that they put that in quotes and also throw quotes around words like “power plant” and “fired up” is that this “Fredonia Reactor” isn’t really a reactor at all, or even, in its broadest sense, even a single power generation site. As far as I can tell when they talk about the “Fredonia Reactor” they’re using that as a catch-all phrase for the wind power resources of the upper midwest — particularly the Dakotas, which are the northern end of the wind belt that has many folks calling the United States the “Saudi Arabia of Wind.”

Insert your own jokes about a big lentil dinner here.

And this would be a good place for your mention of the fact that, as the Gumshoe currently resides in Washington, DC, we’ve already laid claim to the “Saudi Arabia of Windbaggery.”

But back on point — essentially, this massive potential power source is really more powerful than any one nuclear reactor, though that’s perhaps not the fairest comparison (there are plenty of nuclear reactors within the broad geographic area of these “Fredonia Reactors”), and you can probably twist and turn a bit and make those teaser numbers work just fine.

And the Department of Energy did estimate that wind power could provide about 20% of our electricity within 20 years (and estimates since are only increasing with better mapping and taller turbines — a Harvard study assumed using bigger windmills, and using more of the wind-prone areas for generation, and said that the total potential for wind energy generation in the lower 48 states is 16 times current U.S. electricity demand).

There are hiccups in wind power development, of course — it’s probably the furthest along of the “newer” renewable energy sources (ie, it’s further along and usually far more cost effective than solar), but it’s still expensive and it still relies on having a lot of wind turbines on massive towers, sometimes in places where folks would rather not have their views obstructed or their birds confetti’d … or, and this gets to our point, in remote places where they’ve got to build a lot of infrastructure to get the electricity to population centers.

And that brings us to the stock they want to use to profit from this “Fredonia Reactor” — it’s a company that will build new, high efficiency transmission lines to connect the wind resources of the Dakotas and other nearby areas to the national grid and to population centers like Minneapolis and Chicago.

Here’s how they describe this “Smart Electric Co” …

“On April 10, 2009, one tiny company from Michigan received government approval to begin connecting this mammoth power source to cities across America.

“When it does, it’ll tap into an unprecedented surge in annual profit potential.

“This tiny company says that at full capacity, it can transmit 12,000 megawatts of electricity in an hour. In a year, that amounts to 105 million megawatt hours.

“And electricity prices are soaring in America. Wholesale prices for a megawatt hour of electricity have gone as high as $129.48 in cities like Houston. At that market rate, 105 million megawatt hours would sell for roughly $13.6 billion.

“Now this company won’t get every penny of that. But even if they only took in half of those revenues, they’d end up bringing in $6.8 billion more every year.

“That’s 11 times greater than current revenues!

“Certain plays on this company could easily rise 1,099%.

“But that’s just the beginning. With plans to connect more and more cities to the ‘world’s strongest power plant,’ gains could rise to 4,270%… or even 8,132% based on projected earnings alone.

“No wonder Wall Street’s biggest players are buying in ahead of time.

“Along with insiders, firms like Blackrock, Morgan Stanley and Vanguard now own 94% of what could soon be the most important energy company in America.”

This is an interesting company, I’ll give them that — but I just want to note, before I forget, that the idea of the owner of a transmission line getting half of the wholesale price of the electricity they transmit sounds a little far fetched to me (doesn’t mean it’s impossible, I’m no expert on power contracts). The company that wants to build these transmission lines did get their rate incentives approved last April by the feds, but those incentives come out to an effective regulated rate that will allow the project to have return on equity of about 12%.

Before I go any further I should probably tell you who this “Smart Electric Co.” is, right? It’s a company called ITC Holdings (ITC — click here for the free trend analysis on this one), and it is relatively small, about $2.5 billion in market cap, and based in Michigan.

The project that’s being teased here is the planned “Green Power Express,” a high voltage transmission grid that will enable efficient integration of many of those high-density wind areas of the midwest into the grid — and yes, they do project that this totals up to roughly 12,000 megawatts.

This project may well go forward — it sure does seem like we need it — and it may well create a great revenue stream for ITC and their limited partnership that will own the Express … but it’s also worth noting that ITC’s aggressive plan for the project has them putting the Green Power Express in service in 2020, ten years from now. This is still a development-stage project, and it has a long way to go before they could even begin construction (the feds approved their rate structure and incentives, and seem to be supporting the project, but there is a huge amount of state and local regulatory stuff to get through before the final project and routing can be agreed upon, and many utility partners to bring on board, to say nothing of the $10-12 billion that they think this buildout will cost.

Which means that even if the Oxford Club’s fairly rosy-looking projection is accurate (that it could bring in $6.8 billion per year if they got paid a ridiculous amount to transmit this power), the actual revenue from this project is a loooong way off.

Just to square the circle, here’s why the Oxford Club folks are touting the safety of this investment:

“Why the Government Must Legally Get This Done Now…

“The new administration has already mandated 25% renewable energy by 2030.

“The States are joining in too…

“Minnesota is requiring 25% renewable by 2025… Illinois is mandating 25%… Pennsylvania joined in with 18%… Ohio 22%…

“By simply connecting this completed network of powerful turbines to the grid, it’ll instantly be halfway to their goal.

“Perhaps this explains why they gave Smart Electric such an unprecedented deal.

“The Contract That Ensures YOU Get Paid

“As you probably know, electrical transmission is a highly regulated business.

“So when the executives at ‘Smart Electric’ made their deal with the government – outlined in a mind-numbing 595-page tome – they left nothing to chance.

“The contract includes…

“A FERC guarantee of the rates Smart Electric will receive for each megawatt transmitted.

“A ‘Cost Recovery Mechanism’ effectively allowing Smart Electric to send the construction bills for its smart grid to the government.

“A litany of tax incentives giving it an edge over all competitors.

“But perhaps the most important element of the contract is the insurance policy in Section G, part 2.

“In this section it states that, should anything go wrong, Smart Electric will receive back: ‘100% of prudently-incurred costs associated with abandoned transmission projects if the abandonment results from reasons outside the control of management.’

“I know that sounds complicated. But here’s what it means.

“If the government decides to back out, for any reason whatsoever, it has to pay back 100% of Smart Electric’s expenses.”

That sounds like a reasonable, though probably overly skewed to the positive, interpretation of the deal that ITC has for the Green Power Express so far — they basically get to include all the construction costs when they calculate rates that match their mandated return on equity, which is a very similar ROE to what ITC earns now (their ROE for the past year was 13%, a hair higher than the rate agreement for this project)

ITC is a real company and has many other projects, they are profitable and they pay a dividend (a fairly ordinary 2.4%, they’ve been paying out about half of their earnings in dividends), and I agree that it’s probably worthwhile to consider owning good energy transmission companies with the immense need to revamp and rebuild the grid nationwide … but though I suppose it’s possible that “certain plays” on this could rise more than 1,000%, as teased (that would have to be pretty aggressive call options, I imagine), I wouldn’t hold my breath for fast and dramatic returns. If you think that the moment when they “switch on” the grid and connect the “Fredonia Reactors” to the transmission lines will bring a sudden profit burst that drives investors wild with lust for ITC shares, you’ve still got a decade or so to patiently wait for that to happen (and of course, it may not happen as planned).

ITC does a pretty good job of explaining the Green Power Express, including their plans and projections, with plenty of details in their FAQ section here if you’re interested in delving a bit deeper, and their “conceptual map” of the project is here. That site also lists their other major projects/businesses, the ones that actually make them profitable and are the current core of the company.

ITC recently refinanced some debt, they have about as much debt as equity overall (not bad for this kind of company), and they’ve provided projections that they’ll earn between $2.60 and $2.70 per share in 2010 … which means they have a PE ratio of 19 or so — analysts think they’ll grow just a couple percent next year, but they also imagine a future of high-teens annual earnings growth for the next five years, so if that comes through the shares seem pretty reasonably valued. ITC is not quite a utility, since they do wholesale transmission, but compared to most traditional utilities they’re pretty expensive and have a pretty low yield — the SPDR ETF for utilities, for example, has a PE of 12 and a dividend yield of over 4%, even after a nice run for utilities thanks to the renewed enthusiasm of risk-averse investors for boring old utility stocks.

So what do you think? Interested in ITC’s growth potential and fairly solid footing? Think the tease is perhaps a bit overdone? Let us know with a comment below.

And if you’ve ever been an Oxford Club member and read their Communique newsletter, feel free to jump over to the Reviews site and let us know what you thought (or check out the opinions of your fellow subscribers). Thanks!

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Article published January 6, 2010 ⋅  Email This Article ⋅  Print This Article ⋅ Subscribe to Free Daily Update
Subjects: ITC Holdings, oxford club