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

Includes: AEE, AEP, AYE
by: Bill Paul

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 (NYSE:AEP) and Ameren Corp. (NYSE: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.