Investment Implications Of The President's Clean Power Plan

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Includes: FCG, FSLR, KOL, TAN, UNG, UNP, XLU
by: Brad Kenagy

Summary

I examine the details of the President's plan, which in fact shows electricity rates will increase under his plan.

The increase comes from higher-costing renewables and increased compliance costs.

The plan shows little to no desire to expand the capacity of natural gas plants.

In this article, I will be examining the climate change regulations that President Obama released today, and I will be detailing why the plan will end with consumers paying higher electricity bills and the investment implications from the plan. The video below shows a short clip of Brian Deese, White House senior advisor, and if you start playing at the 2:20 mark, he states that the plan will not increase costs but rather consumers will save money.

I find it extremely hard to believe that with solar power (NYSEARCA:TAN) costing more than coal (NYSEARCA:KOL) and natural gas (NYSEARCA:UNG) plants and wind power needing more transmission infrastructure that electricity bills for consumers will decline. I like the idea of reducing coal plants over time and am in favor of using natural gas and renewables. However, I would rather have the market push the transition rather than the government forcing utilities' (NYSEARCA:XLU) hands. In addition, I do not remember a time when the government instituted policies that saved consumers money. This could be a moment like the famous statement President Obama made about consumers saving $2,500/year on health insurance.

Cost to Consumers

Looking at the 300+ page PDF for the Clean Power Plan, I found the following data from tables 3-19, 3-20 and 3-21, which shows that under the rate-based scenario, retail rates will in fact increase. This is in contrast to the statement above from the White House that electricity rates will decrease.

RATE BASED Contiguous U.S. Retail Price (cents/kWh)
2020 10.30
2025 9.90
2030 10.40

Cost Drivers

Utility costs under this plan will rise because solar power especially is more expensive than traditional sources of power. Yes, I understand the health implications of coal and that is why I said above that I like the idea of phasing out coal plants over time by market forces and not by the government's hand.

The EIA puts out a report each year that measures the levelized cost of electricity (LCOE) that represents the per-kilowatt-hour cost of building and operating a generating plant over an assumed financial life and duty cycle. The report for this year shows that of the major sources of energy - coal, natural gas, nuclear, wind, and solar - wind energy has a slight cost advantage over natural gas and both have a large cost advantage over solar, which is the most expensive. Renewable energy sources like wind and solar require more investment in transmission because the locations of these facilities are at a further distance from the power grid than other power sources and thus adds cost. While wind is cheaper, the scale of projects and land needed to generate the same power capabilities of coal or natural gas is substantial. In addition, solar power is even more expensive when government subsidies are stripped out of the equation.

Wind

73.6

Natural Gas: Conventional & Advanced Average

73.9

Nuclear

95.2

Coal: Conventional & Advanced Average

105.4

Solar PV* With Subsidy

114.3

Data from EIA report

Existing coal and natural gas plants that will continue to stay open will have added costs because of additional red tape and increased compliance costs, which in turn will increase costs to consumers. Buried deep inside a massive PDF on the Clean Power Plan, the following table shows that compliance costs under this plan will increase significantly by the time it is fully implemented in 2030. It is highly likely that these compliance costs will be passed on to customers, thus leading to higher electricity bills.

The final item I will touch on is a statement from the "By the Numbers" fact sheet about compliance for the Clean Power Plan. "For States and utilities will have 15 years to meet the final goals by 2030. Investment can begin now, with the period for mandatory reductions beginning in 2022." Therefore, starting in 2022, states and utilities will be forced to reduce emissions and that will increase costs because states and utilities must comply even if it costs consumers more.

Investment Implications

There are significant investment implications for a number of industries under this plan, and I will be detailing each of them below.

Natural Gas

I found it highly illogical as to why there is no mention of expanding the use of natural gas plants when the United States has a massive supply of natural gas. In President Obama's plan, it states "The Clean Power Plan simply makes sure that fossil fuel-fired power plants will operate more cleanly and efficiently, while expanding the capacity for zero- and low-emitting power sources."

"The rate-based scenario finds that in 2025 less coal will be used (102.9 million tons less, a 14.1 percent decrease from the base case) and less gas will also be used (0.1 TCF less, a 1.0 percent decrease)."

The two above statements are very telling because it shows that under the Clean Power Plan, there is no designed plan to expand natural gas capacity like there is a designed plan for renewables. What was really striking was the second statement, which stated that natural gas use will slightly decrease from the base case. What this means for natural gas is that prices will likely be facing pressures for the next 10+ years because of a large oversupply of gas combined with a lack of demand as detailed by the Clean Power Plan. If natural gas prices stay depressed for a long time, then natural gas stocks (NYSEARCA:FCG) will also be under pressure.

Coal

The Clean Power Plan will effectively be the nail in the coffin for coal used for electricity generation. The signs of this can already be seen in the market. The coal ETF has repeatedly hit fresh all-time lows this week and also this week Alpha Natural Resources (ANR) was the latest coal company to file for bankruptcy. As I noted above, starting in 2022, there are mandatory reduction in emissions, which means by that point utilities will be starting to close plants, which will further depress coal demand and prices and the whole process will end up being a death spiral for coal. A further sign that coal demand is already slowing significantly is from the recent Union Pacific's (NYSE:UNP) earnings report which showed that coal volume declined 26%. What all this means is that pretty much any stock that has a significant business in coal will be under serious pressure and should be avoided or shorted for those investors who short stocks/ETFs.

Solar & Wind

With this plan, there will be a significant increase in utility scale solar and wind projects as utilities need to comply with these regulations. With the government effectively declaring solar and wind power the electricity source of the future, solar companies like First Solar (NASDAQ:FSLR) are worth serious consideration because they are indirectly backed by the government because of the mandatory cuts to emissions which will cause existing coal and some natural gas plants to close and the only thing left to fill that void will be renewables like solar and wind.

Closing Thoughts

The Clean Power Plan shows that pretty much no matter the cost, renewables will be forced into the market by the government and that means that the solar and wind industry will have the backing of the government. Under this plan, owning solar or wind companies becomes more attractive than coal companies because untouchable and natural gas companies are somewhere in the middle of that spectrum. While President Obama's goal of cleaner air is admirable and I agree that coal plants should be phased out, his method of the government forcing changes will almost certainly lead to higher electricity prices for consumers. Just look at every other program or industry the government has gotten into and you can easily see that it is highly likely costs will rise for consumers.

Disclaimer: See here.

Disclosure: I/we 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.