Cap-and-Trade Bill Moves Through Congress: Time to Sell Electric Utilities?

Have you looked closely at what will happen to your portfolio if and when carbon cap-and-trade legislation currently moving through Congress becomes the law of the land?

The Investor Responsibility Research Center Institute has. While IRRC finds in a new report that cap-and-trade would depress earnings by less than 1% for about 200 of the 500 firms in the S&P 500, it also concludes that electric utility earnings could plummet, and that three utilities – Allegheny Energy (AYE), American Electric Power (AEP) and Ameren Corp. (AEE) could see their earnings wiped out completely.

Importantly, the analysis assumes that each of the nearly three dozen U.S. investor-owned electric utilities that were analyzed would be obligated to pay for every carbon credit they would need to pay for the carbon emitted over and above the industry’s government-set cap.

This leaves investors to ponder two questions which, at this point, nobody can answer. The first is whether utilities (and all other companies) will in fact be required to buy all the credits they will need under a so-called “auction” process. The power industry is fighting tooth and nail for the federal government, at least at the outset, to make some credits available free of charge. Whether, and to what extent, electric utilities succeed in avoiding having to pay for their credits has the potential to make or break not just the earnings of the three aforementioned utilities but literally the entire industry.

The second question that can’t be answered with certainty at this point is the specific cap that utilities will have to live with. Once again, the industry is fighting for all its worth for a benign cap that won’t severely penalize utilities for operating what the industry knows is an aging, antiquated fleet of coal-fired power plants that regulators won’t allow to be shut down, given that they supply roughly 50% of America’s total electrical generation.

If passed, cap-and-trade likely wouldn’t get underway until 2012, but the fallout on utility stock prices could happen a lot sooner than that. So is now the time to sell Allegheny, AEP and Ameren? Is now the time time to sell every coal-dependent utility in your portfolio?

For conservative investors, the answer may well be yes. For all others, it’s time to keep a watchful eye on Congress.

For more, please see Everything About Investing Is About to Change: Prepare Now to Invest in a Carbon-Constrained World.

Disclosure: No Positions.

Comments

[David Braun...:]

Yes, and it may also justify selling oil producers and oil service companies. I work for an oil producer and we calculated that from the Obama tax disincentives our taxes would rise about 50% even before Cap and Trade. The oil industry will not have any credits as they have a much smaller lobby group than the utilities. Also, with world wide weak energy demand, I believe the current prices are just too high.

Jun 09 08:12 AM

[User 428218:]

I have not seen the IRRC's analysis, but I would guess they did not look at the ability of the unregulated generators to pass through some of the cost in the power markets. Prices in the power markets are set by the marginal unit. Generally, either gas or coal-fired generation is on the margin and setting the price. When coal is on the margin, the price will include the full cost of the carbon credits (because the plant will not run unless it is covering all of its variable costs). When gas is on the margin, even if it is the most efficienct gas-fired generator, the cost of carbon included in the market clearing prices is at least half of the cost of the coal-fired generators.

Therefore, the coal-fired generators, such as Allegheny (AYE), Ameren (AEE) and AEP will recover at least half of the cost of carbon for their unregulated generation. For regulated generation (which is most of AEP's generation and a significant portion of AEE and AYE's generation), the utilities will be allowed by regulators to pass on the costs to end users (otherwise it will be an unconstitutional taking).

Jun 09 08:23 AM

[john s. gordon:]

in order to avoid total disruption, the requirements of the new law (whatever it ends up looking like) will have to be phased in gradually over time.
> jack

Jun 09 09:15 AM

[TCK:]

Unless state regulators will then allow the utilities to pass along all costs to consumers ?

Jun 09 09:30 AM

[bbowen7:]

There may be some transition period and giving of credits, but the whole point of the boondoggle is to drive out coal.

Jun 09 01:21 PM

[Living4Divi...:]

Interesting comment, USer 428218

Are you saying that cap and tax will have little impact on utilities profit margins as the costs will be passed on to the end users?

Also I don't think that the current form of cap and tax is known. Last I heard the government was going to give away permits, thus lessening the tax on the utilities.

Any analysis ?


On Jun 09 08:23 AM User 428218 wrote:

> I have not seen the IRRC's analysis, but I would guess they did not
> look at the ability of the unregulated generators to pass through
> some of the cost in the power markets. Prices in the power markets
> are set by the marginal unit. Generally, either gas or coal-fired
> generation is on the margin and setting the price. When coal is on
> the margin, the price will include the full cost of the carbon credits
> (because the plant will not run unless it is covering all of its
> variable costs). When gas is on the margin, even if it is the most
> efficienct gas-fired generator, the cost of carbon included in the
> market clearing prices is at least half of the cost of the coal-fired
> generators.
>
> Therefore, the coal-fired generators, such as Allegheny (seekingalpha.com/symbo...),
> Ameren (seekingalpha.com/symbo...) and AEP will recover
> at least half of the cost of carbon for their unregulated generation.
> For regulated generation (which is most of AEP's generation and a
> significant portion of AEE and AYE's generation), the utilities will
> be allowed by regulators to pass on the costs to end users (otherwise
> it will be an unconstitutional taking).

Jun 09 06:33 PM

[john s. gordon:]

if the costs of capntrade are passed on to the ratepayers, then the citizens are being hit with a tax that they never voted for & were never led to expect.
> jack

Jun 09 08:29 PM

[fran:]

who ends up paying all costs of legislation?
is there any other source but the public?


On Jun 09 08:29 PM john s. gordon wrote:

> if the costs of capntrade are passed on to the ratepayers, then the
> citizens are being hit with a tax that they never voted for &
> were never led to expect.

Jun 11 01:32 PM

[JCC:]

Historically with each pollution related law, analysts have predicted increased costs to business. In fact, over a relatively short time the opposite has occurred. Alternative and improved methods have been implemented that ended up providing for lower overall costs.

Cap-And-Trade could well end up the same. The costs will yield innovation, which will decrease CO2 emissions. Furthermore, if you look at history, it is likely that this innovation will result in decreased costs to business.

So some electric utilities will make the necessary changes and end up being very profitable. Some will stick their heads in the sand and pay the piper.

Jun 14 09:50 AM

[sethmcs:]

Kill Cap and Trade. Increase coal fired plants to 90 percent of the energy generated. Force CA to use 100% coal power as part of its bankrupcy reorganization.

With love from coal country.

Jun 14 05:40 PM

[pockyclips ...:]

There is no free lunch. Everything has a price. It's high time that all costs are taken into consideration. Isn't that how the "free market " economy is supposed to work? Or are we going to have more of the privatize profits, socialize losses mentality?

Jun 15 08:52 AM

[User 299121:]

well put. I agree


On Jun 15 08:52 AM pockyclips 2020 wrote:

> There is no free lunch. Everything has a price. It's high time that
> all costs are taken into consideration. Isn't that how the "free
> market " economy is supposed to work? Or are we going to have more
> of the privatize profits, socialize losses mentality?

Jun 30 07:41 PM