Don't Blow Your Stack Over the New EPA Proposal

 | Sep 21, 2013 | 4:00 PM EDT  | Comments
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The Environmental Protection Agency has issued a proposed rules to limit emissions from power plants, and the 463-page document is scaring coal-industry supporters. Politicians are jumping all over it as if it were the instant death of coal. However, the concern is overblown, and the opportunities have gotten obscured in the process.

The rule is about carbon dioxide and power plants -- and the EPA is agnostic as to the sources of that gas. Carbon dioxide could come from any variety of power plant fuels, be it coal, natural gas or oil. No matter the source, the EPA wants to limit carbon dioxide from utility smokestacks to 1,000 to 1,100 pound per megawatt-hour.

For several reasons, EPA's proposed standards are not a big deal, and in truth little has changed. So investors focused on coal and utilities need not be concerned.

First of all, the EPA is still at the proposal stage with this -- the rules are not yet law -- and there will be plenty of opportunities for future administrations to make adjustments.

Second, the EPA's proposed rules are limited to new construction, and will not apply to existing facilities. So every coal-fired power plant operating today will remain unaffected, and the same applies to every coal mine feeding those power plants.

Third, plans for power plants won't be heavily affected because very few new power plants are being planned. In fact, over the next two years, hundreds of coal-fired power plants will be exiting the nation's power markets for unrelated reasons.

Fourth, there are existing technologies that currently meet or exceed EPA's proposed standards, so the agency will allow new coal-fired power plants to be built as long as plants' emissions do not exceed limits.

At this point, it appears the EPA's regulations will create far more winners than losers, and the biggest winner will be nuclear power. Nuclear power plants are carbon-free so, as a result, they are immune from these rules. Because new coal plants will have higher capital expenditures, a new nuclear plant will have an improved competitive advantage over a new coal plant.

Another big winner will be manufacturers of combined-cycle gas turbines. Most of these already meet the EPA's proposed standards. Companies like General Electric (GE) and Siemens (SI) have off-the-shelf technologies that are highly efficient, have low production costs and meet or exceed EPA standards.

The EPA's regulations do not spell the end of King Coal, either -- and, in fact, coal will be another victor here. Here are two reasons why.

First, coal-fired power plants owned by such companies as NRG Energy (NRG), PPL (PPL), American Electric Power (AEP) and FirstEnergy (FE) are immune from the proposed regulations. They may continue operating unimpeded as they continue buying coal such names as Peabody Energy (BTU), Consol Energy (CNX) and Arch Natural Resources (ANR).

Second, the next-generation coal plant will become the new standard for burning more coal. KBR (KBR) and Southern Company (SO) developed, implemented and constructed a successful integrated gasification combined cycle (ICGG) clean-coal technology. Southern's new Kemper County IGCC facility has just reached the first fire of the facility's two combustion turbines, which had been completed Aug. 28 and Sept. 4. Other utilities can use this technology to build, own and operate a fleet of IGCC turbines.

Away from this, here's another winner from the new EPA rules: generators bidding into regional transmission organization (RTO) capacity markets. Competitors can no longer throw in cheap gas turbine to win capacity auctions, so companies like Exelon (EXC), AEP, NRG Energy and FirstEnergy should see healthier margins starting in energy year 2017-2018.

One last group of beneficiaries, finally, will be engineering and construction contractors. Since the capital expense for new coal plants will increase, companies like Chicago Bridge & Iron (CBI), Fluor (FLR), KBR and URS (URS) are bound to see higher-valued projects.

The losers will be the bottom-fishers. No longer will simple boiler manufacturers or cheap gas turbines be able to sell simple turbines to American utilities. Except for the small turbines (25 megawatts or less), most of those manufacturers have moved on.

Keep in mind that the above-mentioned winners won't all see improved markets right away. For the next several months, utilities will be cleaning out inventories of old power plants, and it will take a couple of years before power markets will need new capacity.

Also, in all likelihood, coal miners will see a dip in demand. However, as new IGCC power plants come on line, miners may see demand for their coal restored.

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