It's Not a War on Coal

 | Jun 06, 2014 | 5:00 PM EDT  | Comments
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Conventional thinking has natural gas as the big winner in the Environmental Protection Agency's (EPA) proposed regulations on carbon dioxide. Natural gas is considered a winner because it is first among the carbon producers. However, the EPA's biggest winners are energy efficiency, solar power and wind power.

The confusion comes from the media. Some people frame the EPA's regulations as a narrow war on coal. It is not. It is a broader war on carbon. The whole idea behind the EPA's rule is to push carbon dioxide out of the power markets. This includes exhausts from burning natural gas.

Natural gas produces massive amounts of carbon dioxide. According to the EPA, the average emissions rates from natural-gas-fired generation are 1,135 pounds per megawatt-hour of carbon dioxide, 0.1 pounds per megawatt-hour of sulfur dioxide and 1.7 pounds per megawatt-hour of nitrogen oxides.

To put natural gas in context, a 750-megawatt power plant would produce about 6 billion pounds of carbon dioxide per year. It would also produce 10 million pounds of nitrous oxides and 600,000 pounds of sulfur oxides per year.

With these facts in mind, consider the states' position. If you are a policymaker charged with implementing the EPA's new carbon regulations, you could authorize permits to build a natural gas plant that produces 6 billion pounds of carbon dioxide. Your other choice would be to authorize facilities that produce zero carbon dioxides. In most cases, this is not a difficult choice, particularly when more than 70% of the American public wants cleaner air.

Some states will cave in and will allow utilities to replace coal boilers with gas turbines. They might argue that some reduction is better than nothing. However, even if a state were willing, utility shareholders may prefer alternative investments, which include energy efficiency and wind and solar power.

Here is the evidence. The same week that the EPA announced proposed carbon rules, Texas announced that it found energy efficiency to be a potential answer to improve its energy system. The Houston Chronicle reports, "Texas' power market could restrain peak demand by 5,000 to 7,000 megawatts through 2032 by exploiting new energy efficiency and through demand-response programs."

If Texas, which sits on billions of cubic feet of natural gas, implements its energy-efficiency measures, it will be consuming a lot less natural gas. Since Texas has a capacity and carbon problem, it is highly likely that it will implement energy-efficiency measures soon.

Other states plan similar programs. As previously reported, New York is also considering aggressive energy efficiency measures at the distribution level. So is New England.

It appears that the EPA's rule will stimulate investments in energy-efficiency programs. As such, companies such as EnerNOC (ENOC), Comverge (private) and OPower (OPWR) should find their top-line revenue grow over time.

Next in line are wind and solar power. However, investors should draw a sharp distinction between manufacturers and buyers of wind and solar assets. Buyers of assets should garner investors' attention. Buyers will become power producers, and they will harvest most of the benefits, including displacing carbon from the power markets.

The largest fleets of wind power facilities are owned by NextEra Energy (NEE) and NRG Energy (NRG). Keep in mind that notwithstanding congressional inaction, existing wind facilities earn limited production tax credits for the first 10 years of the facility's life. After 10 years, wind facilities earn no tax benefits, and they incur no depreciation expenses, but they deliver bottom-line earnings.

Because utility-grade solar farms are natural peaking facilities, they offer states the greatest opportunity to reduce carbon dioxide. Solar farm owners do not earn production tax credits. They earn depreciation, or an investment tax credit in lieu of full depreciation. Owners of large solar farms include Berkshire Hathaway (BRK.A), NextEra and Southern (SO). However, as explained previously, I would avoid SolarCity (SCTY) for now.

Solar power is set to explode. A lot more solar power is on the way. According to the Solar Energy Industry Association, about 26,500 megawatts of new solar are actively under construction or development.

The EPA's proposed rules will also benefit nuclear power and utility-scale battery companies. Nuclear power emits zero carbon dioxide. However, as described earlier, the EPA's rule presents a mixed bag for nuclear.

Batteries displace carbon dioxide. Investors should avoid companies that rely on older lithium technologies as their base. Instead, they should find opportunities to participate in private-equity deals from places such as Argonne National Laboratories and MIT.

Investors who like natural gas should be fine. As long as citygate prices remain low, utilities will continue using gas-fired generators. A few, particularly in regulated states, may even build a couple of advanced generators. So, smoke 'em if you've got 'em.

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