Renewable Energy and Wireless Telecom Battle Government Policy

Includes: AAPL, DUK, DYN, EIX, GOOG, HNP, S, T, VG, VZ
by: Roger S. Conrad

They were out-spent and out-flanked by much larger rivals in the fossil fuels business for decades. But the renewable energy industry is now flexing its lobbying muscles in Washington, DC.

At stake is about $11 billion in subsidies and research money, as well as potential new federal rules that would mandate construction of thousands of megawatts of new wind, solar, geothermal and biomass-fueled power plants.

This “best of times” for the renewable energy sector, of course, corresponds to a challenging period for producers of conventional energy, particularly of the oil, natural gas and coal that fuel more than three-quarters of America’s power plants and nearly 100 percent of our transportation.

Already gone or severely endangered are the subsidies and favorable regulatory and tax treatment that crested during the reign of President George W. Bush. Meanwhile, the risks of damaging fines and other penalties continue to grow up and down the energy chain.

Last week, the US Dept of Justice (DoJ) joined Illinois Attorney General Lisa Madigan in suing Midwest Generation for allegedly failing to install proper pollution controls on six power plants in violation of the Federal Clean Air Act. The complainants seek an order from the US District Court in Chicago for an immediate shutdown of the plants along with a directive requiring the company to install the “best available pollution controls.”

The filing is a sharp escalation of the issue, which Midwest Generation’s owner Edison International (NYSE:EIX) has been working to resolve with state officials for more than two years. It doesn’t preclude the possibility of an amicable resolution. Neither is the likely financial burden, even in a worst-case, a serious threat to Edison’s financial health.

Edison’s Southern California Edison utility unit is in the pink of health thanks, ironically, to rapid California-backed expansion in renewable energy. Moreover, the company has been taking steps to reduce its exposure to environmental problems at Midwest.

And at least some of its efforts to clear the air have been noticed by regulators. That includes Illinois Environmental Protection Agency Director Doug Scott, who was quoted as “commending Midwest Generation on their efforts” regarding mercury emission reductions.

The joining of a state suit by the DoJ, however, is a stark indication that the Obama administration can and will use sticks as well as carrots to advance its energy policy. At present, 50 senators hail from states that rely on coal to generate at least 50 percent of their electricity, and they’re going to moderate the anti-coal impact of any cap-and-trade legislation that reaches the president’s desk.

Enforcement, however, is another matter entirely. And the willingness of the DoJ to flex its muscles on these issues is a clear warning to owners of existing coal power plants, as well as the rapidly dwindling ranks of those still building new ones.

One of these is Duke Energy (NYSE:DUK), which is currently constructing state-of-the-art integrated gasification combined cycle units in Indiana and North Carolina. When completed, the new plants will substantially eliminate emissions of acid rain gases, mercury and particulate matter by gasifying the coal they burn.

These plants are also being built with the idea of retrofitting to sequester and store carbon dioxide (CO2). And because they essentially recycle heat from their process to produce additional electricity, they’re more than twice as efficient as conventional coal plants. That means they essentially already cut CO2 emissions in half from the levels of conventional coal plants.

Duke’s certainly having no problem accessing capital cheaply. Last week the company sold $500 million of 10-year bonds at a premium of just 160 basis points to Treasuries and another $500 million of five-year paper at a premium of just 145 basis points. That was an increase from the original intent of issuing $800 million and represents the lowest risk premium for A- rated utility paper in two years.

And Duke remains a utility leader in employing environmentally friendly technology. Earlier this month, the company announced a potentially major venture with Huaneng Power (NYSE:HNP) to explore a wide range of initiatives to cut carbon emissions, from renewable energy to ways to cut CO2 emissions from coal-fired plants.

Huaneng produces more than 10 percent of China’s electricity and enjoys strong government sponsorship. Both companies already have initiatives under way to sequester CO2 produced at plants and will be pooling their information under the deal.

The Clean Air Task Force out of Boston has stepped forward to commend the deal, as have several other environmental groups. Nonetheless, the company continues to encounter significant opposition, both in the courts and before regulators, as it moves toward completing the new plants. And opposition to new coal plants has all but stymied activity from those less financially powerful than America’s third largest power producer.

This month, for example, Dynegy (NYSE:DYN) was forced to back out of a venture with privately held LS Power, unloading its share of eight plants (25 percent of prospective generating capacity) now under development for $1 billion in cash and another $500 million in cancelled stock.

The company will write down $405 million and use the cash to cut debt and improve liquidity. That will likely keep it solvent, at least until further restrictions and financial burdens on its fleet of 20 fossil fuel plants in seven states kicks in.

The real financial and regulatory burden on coal miners, coal-fired power plant generators and others involved with the black mineral will only be revealed over the next several years. And because the market has already reacted to drive down prices of the supposedly at risk, it’s likely the lifting of uncertainty as details come clear will prove a bullish event to the strong.

On the other hand, until those details do start to come in more clearly it’s best to avoid the weakest of the exposed. Stronger outfits like Duke, for example, will benefit as the clouds of prospective regulation blow away. And they’re strong enough to weather even particularly harsh (and still highly unlikely) action in the meantime.

The same can’t be said of financially challenged Dynegy, whose bonds are currently deep in junk at a rating of B/Negative from Standard & Poor’s. Nor can it be said about financially weaker producers, shippers and marketers of coal.

Wounding Wireless

A second priority change of the Obama administration affecting essential service companies concerns wireless communications. In recent months, industry giants AT&T (NYSE:T), Sprint Nextel (NYSE:S) and Verizon Communications (NYSE:VZ) have faced a rising wave of lawsuits--mainly from competitors--over alleged uncompetitive practices.

AT&T has been particularly under fire for its exclusive and highly successful marketing agreement with Apple (NASDAQ:AAPL) for the iPhone. The 3G iPhone has been a particular success, stirring discord from a broad coalition of smaller carriers as well as software providers like Google (NASDAQ:GOOG). Smaller carriers claim is that they’re being squeezed out the business by the inability to reach similar deals with the Apples of the world.

Google, meanwhile, is complaining that Apple and AT&T conspired to keep its application for voice messaging off the iPhone. And Voice over Internet Protocol players Skype and Vonage (NYSE:VG) allege that Apple has made it difficult to use their Internet calling services to operate on the iPhone, except in wireless hotspots.

Since his appointment by President Obama earlier this year, Federal Communications Commission (FCC) Chairman Julius Genachowski has reportedly been itching to turn the agency away from the mostly laissez faire policies of the Bush administration.

Last week (his second official meeting), backed by a unanimous vote of the five FCC commissioners, he struck, officially launching an investigation to examine whether there’s “adequate competition” in the US wireless marketplace.

According to Genachowski, “the FCC will have a relentless focus on innovation and investment, on competition and consumers” and that the inquiry will look “broadly at all of the elements that affect what we understand to be the mobile marketplace.”

First steps already approved include examination of ways to make more efficient use of radio spectrum and new requirements for what information must be provided to help consumers choose between competing plans. The agency has also pledged to look at fees charged to customers leaving a contract early.

At this point, it’s unclear just what the FCC will investigate, let alone what it will propose as supposed remedies. It’s worth noting that the activist FCC of the Clinton administration was frequently blocked by representatives and senators of both parties in Congress, as well as the courts.

This week, for example, the US Court of Appeals in Washington, DC, again struck down FCC limits on how much of the cable television markets a single company can serve. The court ruled that the FCC had acted arbitrarily when it reinstated the 30 percent limit in 2007, which another court had struck down six years earlier.

After eight years of Republican rule, the court system is generally well-stocked with judges who believe in less litigation and less regulation. That’s a major plus for companies arguing against an over-reach of federal power based on existing legislation.

Congress may be an easier sell, particularly during a recession when consumer groups are putting on the pressure against fees, including for new services that are now driving data growth of companies. And, with Skype, Google and others arguing for new regulation, there’s financial muscle behind the push as well.

We’ve certainly seen this before, in fact in the last decade under the Clinton administration. Then FCC Chairman Bill Kennard and before him Reed Hundt made it their mission to advantage smaller carriers to the detriment of larger ones, mostly in the name of increasing competition and helping consumers. Their efforts did little to inhibit the reconsolidation of market power in the communications industry, the natural consequence of any scale business.

The FCC can be as political as it chooses to be. And it certainly behooves all the players to try as much as possible to get along with it. Investors should keep three facts in mind here, however.

First, there’s no way of knowing what the FCC will propose and all the players--including AT&T and Verizon--will have plenty of opportunity to make their points.

Second, the FCC is limited by the courts and Congress as to what it can actually do. A particularly harsh proposal could be litigated for years, or certainly far enough off into the future for another election and potentially a new FCC.

Finally and most important, communications company stocks are still the cheapest they’ve been in years. Moreover, underlying businesses of industry leaders are stronger than ever and the business itself is on the cusp of dramatic growth, as new devices, faster technology and better use of spectrum enable an explosion of applications as global connectivity mushrooms.

This more than anything else is why this FCC investigation isn’t a good reason to sell stocks of solid communications companies. And that goes double for those that have performed well as businesses during the worst recession in decades.