SRI/ESG/CSR Research


Bullish on Hydro

There is overwhelming evidence of above normal water levels in rivers in certain regions of the U.S. Various sources show Hydropower production is 144% to 170% above the norm. The recent heat wave has produced record demand measured in degree cooling days in all parts of the US. As a result hydropower utilization has increased to meet demand.

Merchant vendors of Hydro can have very strong operating margins. The operating margins on hydropower facilities have ranged from 60% to 78% for two merchant vendors in Canada. Merchant vendors with the capacity to store power for sale at peak periods will reap the benefits of highest spot prices.

In the event above average heat continues in these regions, the upside on the earnings could approximate those of a large run of the river hydro-facility in the PJN. The President of the company that owns the facility told us that he has already booked 170% of revenues projected for July 2006.

The current conflict between Israel and Hezbollah has significantly lowered prices on all markets and thus has created a buying opportunity. The length of this conflict and perhaps the market's perception as to when the situation is stabilized will greatly influence how much the market will reward strong third quarter performance in the identified companies. For instance today, JP Morgan Chase reported $3.5 billion net income in second quarter 2006 which is more than triple its net income in first quarter 2005. Its stock moved only 3%.

Investment Thesis

The lowest cost method of producing power in North America by a wide margin is hydroelectric.

This year, a late and heavy snowfall in regions of the United States and heavy rains in the Spring and Summer in other regions of the U.S. have resulted in river and reservoir levels at 140% or more above normal levels. Regardless of how cool the remainder of the Summer or Fall is, utilities and merchant generators with significant hydro resources will earn higher net income in the third and fourth quarters this year compared to last year.

For utilities and merchant generators, the change in operating revenues on a year to year basis will be substantial. These utilities have experienced drought and accordingly below average water levels for the past six years. Utilities that have hydropower will also benefit in substituting hydropower for open market purchases or expensive fossil fuels, especially at peak levels of demand. Merchant generators who can sell into certain regions of the U.S. will benefit.

Here is how the portfolio has done (Top: 1 year):

Hydro One

(Bottom: 3 months) Hydro Two

The fact that earnings of the merchant generators of hydro and hydro-utilities rise significantly or even substantially in the third and fourth quarters is insufficient to support a forecast of higher prices. Equity markets, as measured by the Dow Jones Industrials, S & P 500, or NASDAQ, have lost value for much of this calendar year due to inflation curbing Federal Reserve Bank interest rate hikes, sustained high oil prices, and the recent outbreak of another conflict in the Middle East; this time between Israel and Hezbollah (and possibly Lebanon, Syria and Iran).

These conditions have greatly moderated prices for high performing companies reporting second quarter results. Conversely, the shadow cast by these conditions has made now a very good time to buy quality companies.

NOTE: interested persons may subscribe to the portfolio via FolioFN:

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For more information, contact us at 202-455-0430.

Data provided in the section above are for information only, used to explain one possible outcome from our Hydro investment process. The Creative Investment (CIR) Hydro portfolio consists of a portfolio of stock issued by companies, and, like all equity investments, may fall or rise in value. Performance figures have not been audited. CIR Hydro portfolio annualized returns have been calculated based solely on the return of principal and interest and do not reflect the reinvestment of principal and interest. We note that past performance is not indicative of future results, which may vary. The figures for the Creative Investment Hydro portfolio do not reflect the deduction of any fees or expenses which would reduce returns.

William Michael Cunningham


  • B.A. (Economics) , MBA (Finance), A.M. (Industrial Organization)