Clean Power Plan May Mean More Green For Investors by Thomas Socha, AllianceBernstein

The Obama administration recently introduced its Clean Power Plan, which aims to combat US climate change. This groundbreaking project will clean the air and transform how we generate power. Will investors breathe easier as well?

The Environmental Protection Agency’s (EPA) plan has one main goal: to reduce carbon emissions from US power plants by 32% below 2005 levels by 2030 (Display). We believe the project is aggressive—but achievable.

Clean Power Plan

Carbon Limits by Plant Type

The EPA started by looking at all carbon-emitting plants—mostly coal and natural gas. It set limits on how much carbon each type can emit. Coal gives off more carbon than an equivalent amount of natural gas, so the limits for a coal-fired plant are higher.

Plants operating above those limits will need to make changes. But change doesn’t come cheap. The only way to capture excess carbon is with an expensive process known as sequestration, which stores carbon below ground. If plants can’t capture the carbon they emit, they may need to purchase what’s known as a carbon credit offset—that is, credit from plants that use renewable sources of energy (see below).

Road Map for Reduction

Next, the EPA gave each state a specific carbon-output goal, based on the type and number of plants in each state. A state with a lot of coal-fired plants will have to reduce its carbon dioxide emissions by more than a state with no coal-fired plants. States must submit plans for lowering carbon output by 2018.

For all states, the EPA had three primary recommendations:

  • Improve coal plant efficiency. Efficient plants don’t burn as much coal, so they don’t produce as much carbon dioxide.
  • Use natural gas plants more. Combined cycle natural gas plants have been running at less than 50% of capacity. Essentially, the EPA is saying to burn them more.
  • Adopt renewable energy sources. The EPA is encouraging states to switch to solar and wind power. Plants using renewable energy sources can get carbon credits, which they can then sell to carbon-emitting power plants to reduce their allocated limit.

What Does the Clean Power Plan Mean for Investors?

Investors need to understand that some types of utilities stand to benefit more than others from the new regulations. And how they fare depends mainly on their ability to bill customers.

There are three types of electric power companies in the US. Regulated utilities control the entire power flow. They generate the power, own the wires and distribute the electricity to customers. Utilities in states that have been deregulated (this started in the 1990s) only maintain the infrastructure, or grid, that delivers the power, and service the customers. Utilities in deregulated states buy the power sent to their grids from independent power producers (IPPs)—who generate the power and sell it into a power market.

Regulated utilities are all but guaranteed to recover the cost of conforming to the new rules. That’s because the higher costs can be passed along to their customers through rate increases—as long as those rates stay reasonable.

However, there is some risk for regulated utilities.

State governments are generally quite cautious about allowing public utility companies to recoup all their capital expenditure by raising rates—they must protect customers’ rights too. But many of the states that must reduce carbon emissions the most—North Dakota, Montana, Wisconsin and Wyoming—have generally business-friendly regulatory environments. And because the EPA and state regulators are working together on these plans, regulated utilities are less likely to get pushback for passing costs along to customers.

IPPs with large coal portfolios face much higher risks. They operate in a competitive environment and can’t count on raising rates to recoup costs. If they raise the price of the power they sell to reflect increased costs, their customers—utilities—may shop elsewhere. Some IPPS may be forced to close power plants.

Renewable Energy Is the Biggest Opportunity

The growth of renewable power generation seems to hold the most investment potential. If states follow EPA recommendations, the use of wind and solar energy would almost triple. This spotlight on renewables is likely to be a source of growth for regulated utilities. They’ll need to build more renewable power plants, which can justify higher electric rates. So profits could increase down the line.

However, renewable plants are costly to build, and utilities would likely need to raise funds by issuing bonds. Utilities and investors could benefit from the issuance of green bonds, which support projects to abate climate change.

Who else could benefit? IPPs that generate power from cleaner sources such as natural gas, nuclear energy or renewables—anything but coal—are among them. If power prices go up because of the costs of complying with the new regulations, which is likely, IPPs that produce less of their power from coal will see higher profit margins.

Reducing carbon emissions in the US is an achievable goal, and investors can benefit, too—as long as they do their research and know who stands to profit from the greening.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.