Recent US power shortages have left the Bush administration scrambling to develop a national energy policy and Californians sitting through brownouts. Yet for a power industry emerging from deregulation, the fundamental shortage of electricity has contributed to an unexpected success story: a new breed of power generation and electricity wholesale-trading companies. Many of these "upstream" companies, often created when utilities floated their deregulated generation businesses, have become stock market favorites. They are riding high on soaring prices coupled with the appetite of the capital markets for high-growth companies in the old economy.

Even as NASDAQ fell by 45 percent in the 12 months leading up to May 2001, the S&P 500 electric utility index rose by 37 percent. Traditional integrated utilities—especially those with strong upstream businesses—made substantial gains, but pure-play companies that focused on the upstream business performed better still: the stock price of power generators such as NRG Energy and Calpine and of wholesale traders such as Dynegy rose by anything from 80 percent to more than 130 percent (Exhibit 1). With annual earnings projected to grow by 20 to 35 percent, the leading companies in this emerging upstream power industry enjoy price-to-earnings multiples in the 20 to...