Updating Our HX Legacy FREE IDEA

In March, we shared a FREE IDEA from our long-term INVESTING publication – HX Legacy.

That idea is independent power-producer (or “IPP”) Talen Energy Corporation (NASDAQ: TLN).

When we gave it to our free readers, the stock was at $87 per share. A month earlier, we gave it to our paid readers, and the stock was at $67.63 per share. At last Friday's close, the stock was at $173.88 per share.

The stock will be down today due to a regulatory decision. We are taking this opportunity to review the story and comment on the decision.

We are absolutely a BUYER of the stock at these levels.

TLN owns a large fleet of electric power plants, including Susquehanna, the country's sixth-largest nuclear plant (2.5 GW).

When we first recommended the company, it had only emerged from bankruptcy less than a year earlier. It was still in the process of restructuring its balance sheet and group of assets. It also was only traded in the over-the-counter stock market or “pink sheets.”

We felt the company would "clean" up its balance sheet and portfolio, uplist on a listed stock exchange, and see much greater analyst coverage as it achieved these goals. As it achieved these goals, the stock would move higher.

All of these goals have been accomplished, and the stock has responded.

You can read our previous reports and updates on TLN at the top of our HX Daily website here.

We did not predict the degree to which investments in artificial intelligence would accelerate when we wrote our report.

We were optimistic about power prices for TLN. We had seen a lack of investment in new capacity and steady growth in demand. We also felt that demand would continue to accelerate, and we would not see a quick or easy capacity response.

The result would be higher prices and positive for TLN’s earnings.

We clearly, though, did not predict HOW MUCH the demand would accelerate.

More than just the demand, the beliefs about future demand. These future perceptions have led several leading technology companies to acquire future power capacity aggressively.

Recently, Microsoft Corporation (NASDAQ: MSFT) convinced leading IPP operator Constellation Energy Corporation (NYSE: CEG) to restart a mothballed nuclear plant at the infamous Three Mile Island facility.

The first major announcement regarding big technology and the nuclear renaissance came earlier in the year back in March.

That is when e-commerce giant Amazon.com, Inc. (NASDAQ: AMZN) announced that it would purchase a data center built by TLN.

Talen had proposed building a data center next to its nuclear plant. The idea was that there would be great demand for data centers in the future, and having one right next to a nuclear plant would be advantageous.

One of those advantages was (is) ready access to a reliable stream of clean power.

Another was that they would be able to supply cheaper power as they would feed the power straight into the data center. They wouldn’t have to use anyone else’s “pipes” and pay a fee for doing so.

The company announced this project (called Cumulus Data) in May 2021. By January 2022, they had completed the facility and were able to take on their first tenant.

This project was approved by all relevant regulatory bodies, including the PJM Interconnection organization (which governs utility connections in its region) and the FERC or "Federal Energy Regulatory Commission," (which regulates the electric industry nationwide).

On March 4, 2024, the company announced it would sell the project to Amazon. Amazon would pay $650 million, including $350 million at closing. The deal closed in March 2024 and does NOT need further regulatory approval.

On Friday, November 1, the FERC rejected a particular aspect of the Amazon deal, which is pressuring the stock today.

Here is our commentary on the situation in an FAQ format:

1. What exactly did the FERC reject?

The current data center at the Cumulus site has been permitted to consume 300 MW of power.

We believe that this power is being consumed “behind the meter.” This means AMZN and TLN are not paying third parties to transmit this power. The facilities are right next to each other – why would they?

AMZN and TLN applied to the FERC to add an additional 180 MW to this "behind the meter" arrangement so they could expand the facility with this cost-advantaged power.

The FERC (in a two-to-one) vote rejected this application. You can access their decision here.

2. Does this mean that FERC has rejected the AMZN data center deal?

No. The deal closed in March.

This application was only to add 180 MW (the 300 MW to 480 MW) to the previous "behind the meter" deal.

The AMZN deal is done, and this does not change it.

3. Why would the FERC reject the application?

The FERC committee members who rejected the application said the agreement could "raise power bills and affect the grid's reliability.”

There was also the following statement….

“Co-location arrangements of the type presented here present an array of complicated, nuanced and multifaceted issues, which collectively could have huge ramifications for both grid reliability and consumer costs,” FERC Commissioner Mark Christie said in the order.

4. Why would the AMZN application to expand capacity “raise power bills”?

The electric utility infrastructure consists of power generation (the power plants where the power is made), transmission (the "bigger pipes" that go between the power plants and the customers), and distribution (the "smaller pipes" that go to homes and businesses).

In response to the AMZN deal, two large utilities, American Electric Power Company, Inc. (NYSE: AEP) and Exelon Corporation (NYSE: EXC), challenged the application.

These companies run large transmission and distribution systems in the region where Talen operates.

They argue that when the complex regulatory pricing mechanism was developed for the PJM region, this 180 MW of power was included in the equation.

This means they are being compensated for operating this network based on “X” amount of generation in the region. This deal would spread that transmission cost over a smaller base – the equivalent of “X” minus 180 MW. As a result, prices to consumers would go up.

This DOES make sense.

Let’s do some quick back-of-the-envelope math. PJM is estimated to operate with 180,000 MW or 180 GW of power generation capacity.

Suppose this 180 MW were to be subtracted from the base; that would be a 0.10% reduction in the base. All other things held equal, this could result in an increase of +0.10% to the transmission portion of the consumer bill.

Transmission typically accounts for 15% to 25% of the consumer’s electric bill. Using the 20% midpoint and the +0.10% increase, the AMZN deal would increase consumer prices by +0.02%.

AEP and EXC argued that it could impact PJM ratepayers by $140 million per year.

We don't have the total amount of electricity spent in PJM, but the region has 65 million people. There are 335 million people in the USA, so that is roughly 20%. It is one of the most developed areas in the country, so we think it makes up 25% of the US power market.

The market is estimated to be almost $500 billion in 2023. Their number would have an impact of a little more than +1% on the market.

Which estimate is correct? No one knows, but the number is small.

5. Why would the AMZN application to expand capacity “affect the grid’s reliability”?

The 180 MW that the data center would incrementally use would be power that would no longer be available to the overall power pool.

With less power in the pool and the same amount or more demand, there is a bigger mismatch between capacity and consumption, which makes the system more unstable.

How is this different than if AMZN just built a new data center that consumed 180 MW of power generation?

It isn't. If they did that, there would be an incremental 180 MW of demand. Instead of the power pool being 180 MW out of balance by losing that supply, it would be out of balance by seeing increased demand.

The demand is coming, and the capacity must be built to supply it.

6. These seem immaterial, why did FERC reject the application?

This is why we included the last statement, in which the FERC commissioner discussed the enormity and complexity of the situation.

The AMZN application doesn't really affect the market or consumers, nor does it affect AES or EXC.

However, if one hundred more "behind the meter" deals occur in the next few years, it could have a material impact on the overall market. Prices could go up, and reliability could go down.

We think the FERC is rejecting THIS application not because of the actual impact but because they need more time. They need to create a framework to deal with the effects of many more deals like this one.

This isn't speculation on our part. The FERC has been holding hearings on the subject, and some of these were held last week.

7. What happens next for TLN?

We believe that AMZN and TLN will rework the deal for the additional capacity and offer to pay (some or all) of the transmission costs they would have avoided with the “behind the meter” deal.

How large of an impact would that be?

As we mentioned before, transmission costs in PJM usually make up about 20% of the total bill. We think that is a good proxy.

As a result, we think AMZN will come back and agree to pay around 20% more, which will be passed on (through Talen) to the transmission owners.

Would AMZN be willing to pay more?

Our understanding is that AMZN will pay a price over $70 MWh in the future. Current power prices in the PJM region are around $45 MWh.

They are willing to pay this premium for the visibility of having this reliable and clean power.

Our understanding is that Microsoft is paying over $100 MWh for the returning Three Mile Island nuclear capacity. (By the way, THIS capacity was not factored into the PJM base, so it would not be subject to the same ruling.)

If this is all correct, AMZN could pay the premium of +20% and still be at a steep discount on what MSFT is paying.

Would AMZN be willing to pay this premium? ABSOLUTELY.

These major technology companies understand that we simply do NOT have enough power capacity to satisfy the growth in demand. They also understand that when prices go up, they go up significantly.

The FERC's actions around getting transmission compensated may offset some small increases in consumer power pricing.

These increases, though, are tiny compared to the price increases that will result from the mismatch of supply and demand.

In all scenarios – regardless of any FERC rulings – this will happen.

THIS is the story for Talen. Not some minor regulatory ruling.

8. Is this good or bad for TLN financially?

It would have been better for the FERC to approve the deal and for everything to move forward.

Now, there will be a recast deal and a new submission. We think it will eventually be done.

We believe AMZN will pay the higher costs, which TLN will simply pass through. This means there will be no economic impact.

We also believe any delay in the capacity expansion (what the application was about) will not impact TLN's financials.

As a result, we do NOT think the delay is good, but we believe it will be irrelevant and/or immaterial financially.

9. Is this good or bad for TLN stock?

Today it is bad.

When you have a stock that is +200% year-to-date and has attracted a large number of momentum-oriented investors, any "noise" can lead to a sell-off. Often a steep one.

That is what is going to happen today.

Ultimately, though, we don’t think this ruling will have ANY impact on the long term value of the stock. 

10. What would we do with TLN stock today?

We would BUY TLN stock today.