January 1, 2012 will see the implementation of new EPA rules forcing power plants to curb emissions. While the industry is still fighting the new regulations, a Washington that seems unable to agree on anything seems unlikely to compromise on this issue in the short term. That being said, coal-fired power plants in 27 states are likely in for some retro-fittings, or shut downs over the three year period set aside for compliance to the new rules. That means big changes for power producers and coal miners, opportunities for engineering companies that install scrubbers and build new power plants, the companies that supply these products, and potentially the natural gas industry.
Duke Energy (DUK) and Progress Energy (PGN), which are pursuing a merger, combined would have 57 gigawatts of U.S. generation capacity, with 42% coming from coal. However, the majority of that coal generation capacity already has scrubbers installed. Of the 24.2 coal generating gigawatts, 6.6 GW are unscrubbed, representing only 11% of the total combined capacity of these two companies. This small amount of affected generation is not a huge threat to the combined company, and I believe these stocks are more likely to move on news regarding the merger rather than EPA rules.
The same is true of the proposed Exelon (EXC) and Constellation Energy (CEG) merger. If combined, the company would generate just 6% of its capacity from coal, mitigating any server impact from the new rules. Each stock's performance is more likely to be influenced by news of the merger, than the new EPA rules.
CMS Energy Corporation's (CMS) Consumers Energy recently announced plans to spend $1.6 billion to reduce pollution at coal fired plants. The division also will close 7 smaller coal plants, and install pollution control equipment at 5 larger coal plants, in order to comply with the new regulations. The firm is out in front on the new regulations, and should have little trouble meeting the new rules.
American Electric Power Co. (AEP) and Southern Co. (SO) appear to have the most to lose of the utilities, simply because these two are fighting the regulations the hardest. American Electric has said that the new rules could force AEP to close up to 11 power plants, and that the cost of complying with the EPA rules is about $8 billion. For its part, Southern Co's CEO has said that the company would need 6 years to comply with the new rules, double the allocated 3 years.
As the utilities spend to either build new power plants, or retrofit older plants, investors should expect all the engineering and construction (E&C) firms should win new business commitments. These include Fluor (FLR), Jacobs Engineering (JEC), Shaw Group (SHAW), and Fuel Tech (FTEK). However, for both Fluor and Jacobs, the power business only makes up a small fraction of total backlog, so each name is by no means a pure play. Shaw Group just reported a strong quarter, driven by results in Shaw's power business, thanks to both the management and maintenance of nuclear plants and continued activity in both coal and gas power plants. Fuel Tech, which sells products to help plants reduce pollution, operates in two segments: Fuel Chem, which improves boiler efficiency by treating the fuel source, and Air Pollution Control products that reduce harmful emissions. The company is much smaller than the larger E&C companies, so it could see a larger percentage change to overall sales as utilities work to meet the new regulations.
As for the commodities themselves, while steam coal prices have fallen in recent months, a strong export market driven by growing demand in China should provide a floor to prices. That means recent drops in both Arch Coal (ACI) and Walter Energy (WLT) due to lower shipments should be short lived, as more and more coal goes overseas. As for North American natural gas producers like ExxonMobil (XOM) and Chesapeake Energy (CHK), the lack of export ability in North America will keep a lid on prices until that is changed. Even a shift to new natural gas generation will likely not be big enough to soak up all the excess supply already on the market, and higher prices would likely be met by new production.
While the new EPA regulations will benefit the U.S. as a whole, thanks to more efficient power plants that produce less pollution, expect the utilities who are forced to spend new money to comply to also lobby for rate increases. The E&C firms should see a modest bump in growth, with Shaw Group and Fuel Tech likely some of the biggest winners. Coal miners should see prices and volumes bounce back, as more coal is shipped to Asia, while natural gas producers are still burdened by their own success in unlocking gas reserves.
Disclosure: I am long JEC.