The recent release of new EPA standards on mercury emissions from coal-fired power plants were met with a counterintuitive day of strong outperformance in utility stocks. The DoJ approval of the Exelon (EXC)/Constellation (CEG) merger may have driven much of the price action, though a general perception that the new standards will be fairly easy to meet didn’t hurt. When the Bush administration instituted mercury emission standards with low reduction expectations and a completion deadline of 2018, many states took matters into their own hands. This has created differentials in the impact the EPA’s announcement will have on different power producers.
Illinois’s stringent mercury regulations, put in place under Gov. Blagojevich, mandate a 90% reduction in emissions by 2012, meaning that utility operators in Illinois should already be well on their way to meeting the EPA’s new standards. Exelon, which serves several million customers in northern Illinois via Comed, actually supported the new rules in an interesting strategic move. Exelon shared its support with the Public Service Enterprise Group (PEG), which has benefited from installation of mercury abatement devices due to New Jersey state regulation laws.
If you’re looking for utilities that may struggle to meet the new standards, both Southern Company (SO) and American Electric Power (AEP) resisted the new standards by arguing that the EPA had both underestimated costs of mercury abatement and overestimated the speed with which abatement systems could be installed. The EPA estimates that compliance costs will be $9.6 billion and that compliance should be completed by 2015. Nevertheless, the Electric Reliability Cooperation Council, an industry trade group, published a report suggesting the compliance costs could be as large as $100 billion, though most observers agree that costs will be lower than articulated by power industry trade groups. Ameren (AEE) will be an interesting case study in compliance costs as half of its operations are in Illinois and half are in Missouri, a state with no mercury emission regulations. Unfortunately, it is difficult to gauge how the new regulations might impact the bottom line, as companies will likely ask regulators to adjust rates to mitigate the impact of compliance. American Electric has already said that it expects to request more time for compliance.
The best investment opportunities may not be with the prepared utilities, but rather the engineering companies that will benefit from the contract market for abatement technology. The Shaw Group (SHAW), the construction and engineering company that deals largely with power generation projects, released generally positive earnings yesterday, allowing CEO Jim Bernhard to discuss the EPA’s announcement that morning. The Shaw Group’s view is that about 50% of all coal plants in the U.S. will need to be updated. Bernhard estimated that about $20 billion in market opportunities will be generated from the higher NOx and SOx standards also announced by the EPA, about $20 billion in new construction to replace dirtier plants phased out completely by the regulations, and another $15 billion in projects related directly to mercury emission abatement. This presents a more than $50 billion opportunity over a rather short 3 to 5 year period.
Other companies which stand to benefit along with Shaw are ADA Environment Solutions (ADES), Babcock & Wilcox (through their subsidiary Babcock Power) (BWS), Primoris Services (PRIM), and larger companies such as BASF (OTC:BASFY) and Siemens (SI). All of these companies have emissions reductions operations for SOx and NOx, as well as some mercury abatement operations. There are a several different technologies for reducing mercury emissions, though Activated Carbon Injection seems to be the most popular. This process involves injection carbon particulates into the smoke stacks, allowing the mercury to bind with the carbon particles which can then be separated out of the flue gas by magnetism. Interestingly, ADA-ES’s stock jumped 12.4% on the day prior to the announcement on seemingly no news, suggesting a possible leak of the announcement. ADA-ES’s CEO actually testified before Congress during an inquiry into mercury emissions from coal plants. Babcock Power, ADA-ES, and the Shaw Group will likely dominate the market for new abatement contracts but smaller providers like Primoris may also participate. Chemical companies like BASF will likely provide the carbon and other chemicals needed for long-term use of the abatement technology.