US Coal Utilities: Effects of New Limitations

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

The new climate change plan from Obama’s administration is expected to shift the competitive landscape of energy production in the United States. This will certainly impact coal mining companies and coal-burning electricity producers as the president is developing a plan in which the Environmental Protection Agency (EPA) would limit carbon dioxide emissions from coal and gas burning utilities by 2015 and implement it in 2016. This will be a fierce lobbying battle to set grounds that could benefit either side of the equation, but what is certain is that coal-burning utilities will be hit by this ruling.

The EPA and utilities: round one

There are several utilities that will have to migrate to cleaner sources for energy production or succumb trying. In this article we are going to review what could be the impact of this new climate change policy in American Electric Power (NYSE: AEP), DTE Energy (NYSE: DTE) and Duke Energy (NYSE: DUK).

American Electric Power: An intricate transition

American Electric Power (AEP) will be heavily affected by this new implementation by the EPA because it is highly dependable on coal as it uses more than 70% of that source to generate electricity and only 17% of natural gas. It consumed 57 million tons of coal in 2012 and remained the biggest buyer of coal in the US. Although the company has been decreasing almost all of the toxic emissions, its carbon dioxide emissions are still high at 122 million metric tons and have only been reduced slightly from 2007 to present date.

According to Melissa McHenry, AEP’s spokeswoman, stated that “There’s a significant portion of the current fleet of coal-fueled power plants that is going to be retired in the next few years”; “AEP has 5,000 megawatts of generation that is retiring. About a fifth (of all coal-fired plants) are retiring by mid-2015 as a response to regulations on mercury.” The company’s approach seems to be closing down the coal-burning facilities and burning gas instead. This will generate huge costs for AEP in the coming years. The company posted almost flat operating earnings for the first quarter of 2013 compared to the same quarter of 2012 totaling $387 million and EPS is flat at $0.80 for the same period of comparison. Some companies will try to pass some of the transition costs to costumers and that will be another battle they will have to win. American Electric Power’s share has not suffered the impact of this ruling yet although last month it lost 5.5%.

DTE: Strong balance sheet could be helpful

DTE Energy (DTE) is an electricity producer mainly based in Michigan that will also feel the heat of the new regulation. The main fuel type used for the generation output is coal with 76% and then nuclear with 15%. Shifting to gas or other fuel type to produce energy will impact consumers as some of those hiking costs will also be translated into heftier bills. The company could soothe the EPA’s emissions shock by focusing on other revenue segments it has but it will be costly as electricity accounts for almost 70% of its expected operating earnings in 2013 and gas only 17%.

DTE has some margin to turn around its complicated situation. It has a strong balance sheet as it generated $600 million in cash from operations; it had Moody’s and Fitch credit upgrades; its free cash flow generation stood at $200 million and funds from operations over debt is expected at 22% in the first quarter of 2013. This could give the company some space to increase capital expenditures and modify its plants to decrease carbon emissions. A point worth considering is that Michigan is dependent on this company for electricity and it has more possibilities to increase electricity prices for consumers and lessen the transition burden.

Duke Energy: Diversification is king

Duke is an energy company that serves 7.2 million electric retail customers located in six states in the Southeast and Midwest of the United States. This utility has a diversified portfolio for its Midwest generation mix: 50% from coal, 47% from natural gas, and 3% from oil. This is an excellent way to diversify risks from future regulations and could in fact benefit from the US shale play expansion and its low prices to boost profit margins. A transition for Duke would not be as harsh as for its other peers analyzed in this article. Moreover, Duke operates in Argentina, Brazil, Chile, Ecuador, El Salvador, Peru and Guatemala and also has solar and wind projects in its portfolio which will further mitigate other risks related to the toxic emissions limit.

The company posted a lower EPS of $1.02 for the first quarter of 2013 compared to the same quarter in 2012, but it had share dilution from the Progress Energy merger announced in July 2012 apart from integration costs that affected the company’s earnings. However, Duke posted revenue of $5.9 billion for the first quarter of 2013, up 61.5% from the same quarter a year ago and generated cash flow of $1.3 billion.

Final Comments

From this peer group, the company better positioned for future growth is Duke. Acquiring Duke is a good choice for investors that want exposure to the utility sector in the US, but also internationally as the company has operations outside America. It generates a strong cash flow and has a balanced fuel type generation mix that makes it flexible to changes in regulations which is ideal at this moment. Both American Electric Power and DTE Energy are greatly exposed to new regulations and will have to disburse huge amounts of cash for the transition to gas or other fuels for electricity generation. The best idea is to go long on Duke, but it is also wise to wait until a clear EPA release indicates which will be the restrictions to emissions and assess the real impact on each of these players.

Vanina Egea has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus