Energy Investors Should Not Overreact To New Climate Change Rules

Includes: AEP, DUK, EXC, SO
by: Troy Bayer


The Obama administration rolled out new regulations intended to reduce carbon emissions in the fight against climate change.

States' plans to reduce carbon emissions will not be approved until as late as 2019; hence there is little immediate impact to energy stocks.

There are many challenges, both legal and political, for the regulation to overcome before successful implementation.

The Obama administration announced sweeping new climate rules this week that would reduce carbon emissions from power plants by thirty percent by 2030, compared to 2005 levels. As a result, stock market analysts are predicting dramatic impacts to coal-dependent power companies, like American Electric Power Company (NYSE:AEP) and Duke Energy Corporation (NYSE:DUK), and nuclear generators like Exelon Corporation (NYSE:EXC).

However, investors should avoid the urge to panic and instead take advantage of any bargains that may arise in the wake of the President's major policy initiative. It will take many years for the new regulation to take effect, and furthermore, it will face significant challenges to a complete and successful implementation. This same thought process holds true for companies standing to benefit from a transition away from coal-powered electricity, such as Exelon.

There is some degree of fear in the investing community that AEP, Duke, and Southern Co. (NYSE:SO) will be required to sink considerable capital expenditures to improve energy efficiency and invest in alternative energy sources such as wind and solar in order to meet the administration's requirements. In addition, these coal-dependent companies may be required to spend $1 billion to pay for carbon permits. Officials from the Environmental Protection Agency (EPA) have stated that some of the dirtiest coal plants will be forced to close.

While this may be true, it is important to designate the new regulations as simply a long-term risk. First, and perhaps most importantly, the 30 percent reduction is overstated. Hugh Wynne, the lead analyst for a Sanford Bernstein report on the impacts of the regulation, concluded that CO2 emissions are already down 15 percent from the 2005 levels, and will decline another 5 percent by 2018 simply by proceeding with planned coal plant retirements. Essentially, the United States is already two-thirds of the way towards the EPA's target reduction rate.

In addition to the overstated goal, there are several other challenges the regulation will have to overcome including anticipated lawsuits and a new administration in 2017. The EPA will most certainly be taken to court for the proposed rules. The legal authority for the regulations are centered on a little used section of the Clean Air Act that covers pollutants not specified elsewhere in the bill. This provision has not passed the scrutiny of the Supreme Court and there is no legal precedence supporting its usage.

Another legal issue stems from the EPA's decision to vaguely combine coal and gas-powered plants into the CO2 reduction targets, instead of breaking down specifically by the dirtiest plants. Paul Bailey, vice president for federal affairs at the American Coalition for Clean Coal Electricity, believes the Clean Air Act authorizes regulation of plants, but does not allow for state-specific regulation.

While none of these legal points may hold water in federal court, they will undoubtedly produce uncertainty around the proposed rules and delay its implementation. Environmental regulators from several heavily impacted states wrote to EPA Administrator Gina McCarthy stating that states were absorbing unfair risk by moving forward with CO2 reduction plans prior to resolution of the litigation that will be certainly be filed.

The pending legal fight raises many questions, but the fact remains that the EPA's timeline removes any potential benefit or risk for investors in the next half-decade. The EPA set the deadline for states to submit CO2 reduction plans by 2018. Yes, you read that correctly - 2018 - as in over four years from now just for the plan submission. Following the plan submission, the EPA has a full year for review, pushing any implementation to 2019. Sounds like a plan with all bark and no bite.

Hanging over the entire process is the fact that a new administration will take executive power in January 2017, which is at least two years prior to implementation of the plans. If a Republican president is elected, there is a good chance that the proposed rules will be scuttled indefinitely.

In the distant future, circa 2020 and beyond, there may be a demonstrable impact to coal-producing plants and clean energy alternatives such as wind, solar, and nuclear. However, in the near term, investors should not make hasty decisions in light of the proposal, and instead take advantage of any unsubstantiated dips in the share price of coal producers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.