The Best Place to Waste Your Energy

Maxxwell A.R. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Traditional sources of energy – coal, natural gas, nuclear – are always in the headlines. They have ample government policies and regulatory frameworks that govern their use and guide investment. The market of energy-from-waste (EfW) does not have the same amount of fanfare or oversight, but don’t throw the industry into your waste bin of investing ideas just yet. EfW technologies have one important thing in common with those of traditional energy generation: ridiculous supply. In fact, when coupled with other key advantages, EfW may actually be favored for keeping the country’s lights on.

Waste not, produce more

The obvious investment in EfW is Covanta (NYSE: CVA), which processes over 20% of all recovered municipal waste in the U.S. every year. That equates to 20 million tons of waste being converted to 9 million megawatt hours of electricity. Think that’s insignificant? Think again. Covanta produces about 10% of Calpine Corporation’s (NYSE: CPN) clean energy-heavy capacity and 5% of NRG Energy’s (NYSE: NRG) capacity after accounting for the GenOn acquisition, which rank third and first in generation capacity, respectively. Those figures are also double the capacity of much larger rival Waste Management (NYSE: WM).

A total of 86 EfW facilities – 40 of which are owned by Covanta, 17 by Waste Management – add 2,572 megawatts of annual generating capacity to the national power grid. Ok, so that’s not a shockingly high number. But there is plenty of growth left. While Americans are becoming slightly less wasteful, the total recycling rate is still only about 34.1%, which leaves plenty of room for growth.

<img src="/media/images/user_6293/msw_generation_1_large.PNG" />

<img src="/media/images/user_6293/msw_recyclingrates_large.PNG" />

Source: EPA.gov

The growth multiplies when you consider the following:

  • According to the EPA, the roughly 250 million tons of municipal waste produced annually may only represent 2% of the country’s total waste. Not all waste can be converted into energy, but you have to like the opportunity.
  • Not all recycled waste is currently converted into energy.
  • EfW facilities reduce landfill volumes by 95% - the equivalent of taking 19 of every 20 garbage trucks out of the equation.
  • Where there are humans there will always be waste.

Astonishingly, it gets better: The numbers above only represent what’s left for American growth. Covanta and Waste Management are both targeting higher growth emerging markets, which have much more chaotic waste removal systems. That chaos represents a major opportunity.

Trading carbon is so yesterday

Nearly all of Covanta’s projected $250-$265 million in free cash flow in 2012 will go towards the annual dividend. It’s tough to argue with shareholders who want more of that total to go towards growth opportunities. While management has no plans to cut the payout, the company could get a major new revenue stream from the introduction of a carbon swaps system. Such a system is considered a "stickier" idea for businesses and politicians than a carbon trading system, which alone could halve the deficit by 2022.

Let’s run through some numbers for a possible carbon swap scenario. For every ton of waste an EfW facility converts to energy, one ton of greenhouse gases is offset. Over the years Covanta estimates that it has kept 350 million tons of greenhouse gases from entering the atmosphere – the equivalent of planting 8 billion trees.  On a yearly basis and using World Bank estimates for one metric ton of carbon ($20), Covanta would generate an additional $400 million in revenue without lifting a finger. 

Seeing that most of the greenhouse gases offset by EfW facilities are in the form of methane (that would otherwise be emitted from a landfill) and using the simple fact that methane is 20x more polluting than CO2, weighting greenhouse gases by their effect on the atmosphere would provide even more revenue.

Foolish bottom line

Unfortunately for Covanta and Waste Management, there is currently no carbon tax or carbon swapping system in place. That could soon change with the world becoming increasingly more aware of human effects on climate. Even without carbon swaps, Covanta and Waste Management sport market beating dividends with 3.5% and 4.5% yields, respectively. How much higher would they be otherwise?

Both companies have carved out a profitable niche in an industry that has been all but neglected by emissions and renewable energy standards. That is no simple feat and means they are well positioned to capitalize on any new policies or regulations that may be passed. Look at it this way: Government regulation will only be a boon for business. I think it’s a question of when, not if.

Follow me on Twitter to keep up with my future posts on energy, sustainable chemicals, and undervalued growth companies @BlacknGoldFool.

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BlacknGold has no positions in the stocks mentioned above. The Motley Fool owns shares of Covanta Holding and Waste Management and is short Covanta Holding. Motley Fool newsletter services recommend Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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