The Clean Power Plan: Rise of the Sun Kings

Investing Daily Article of the Week

by Richard Stavros

After two years of intense lobbying from both utilities and environmental groups, the Obama administration has unveiled the final rules for its Clean Power Plan, which aims to dramatically cut carbon emissions from the power sector.

The new regulations, which will be implemented by the Environmental Protection Agency (EPA), force significant, structural changes in the way the industry operates. In particular, it compels far greater adoption of cleaner sources of energy.

To be sure, the Clean Power Plan faces a host of legal challenges, but most industry insiders believe it will survive largely intact.

As we noted two years ago, when these rules were first proposed, the power sector’s historical value proposition would be upended in this process, thereby creating a new premium for low-carbon emissions utilities.

At the time, we predicted the rule would spur utilities to become greener, leading to the rise of the industry’s new sun kings.

We said utilities such as Dominion Resources Inc. (NYSE: D), NextEra Energy Inc. (NYSE: NEE) and Sempra Energy (NYSE: SRE) would rank among the newly anointed sun kings. And that day appears to be upon us.

The final version of the EPA’s Clean Power Plan both tightens and relaxes key regulations seen in its previous proposals.

Emissions reduction targets have been toughened, with a goal of achieving a 32% reduction in carbon emissions by 2030, based on emissions levels from 2005, up from the 30% reduction specified previously.

But the EPA is also giving states up to two more years to submit plans for how they expect to achieve such cuts, while also extending the deadline for utilities to be in compliance by two years, until 2022.

As The Wall Street Journal observes:

“Cutting carbon emissions 32% by 2030 will require billions of dollars in investments to pay for new transmission lines that accommodate more solar and wind power and new pipelines to fuel natural gas fired generation, as coal becomes less important as a fuel for power plants.”

Such spending will actually be an earnings boon for many utilities, as these projects get added to rate base.

Meanwhile, as we noted in the latest issue, some utilities are already taking advantage of the energy sector downturn by buying stakes in proven natural gas reserves to lock in bargain prices, while ensuring a steady supply of the increasingly crucial fuel.

And the Clean Power Plan should also be a windfall for midstream companies, as greater demand for cleaner-burning natural gas for power generation results in a massive buildout of the pipelines needed to deliver it.

Despite some misgivings, the utility industry seems to be largely on board with the new regulations. Indeed, a number of utility executives that we chatted with at the Edison Electric Institute’s Financial Conference said their firms have already made significant strides toward compliance.

In fact, some of these changes have simply been prompted by market forces rather than regulation, particularly the abundant supply of cheap natural gas resulting from the Shale Revolution.

Whatever the reason, actions speak louder than words. Utilities have been retiring coal plants in greater numbers in anticipation of these regulatory changes. More than 42,000 megawatts (MW) of peak coal-fueled generating capacity, or about 13% of total U.S. coal fired generation, is expected to be retired by 2025.

Of course, as the old saying goes, the devil is in the details. The extent to which utilities will benefit from the Clean Power Plan depends in large part on how the states in which they operate plan to comply with it.

For subscribers, we identify how some of our top holdings will benefit from the plan.