President Barack Obama delivered a major policy speech on climate change at Georgetown University at the end of June. In directing the Environmental Protection Agency (EPA) “to complete new CO2 pollution standards for both new and existing power plants,” the speech was significant in several ways.
First, it elevated the issue of climate change on the national political agenda and suggested that reducing carbon emissions would become a major priority for the president’s second term. Second, the speech indicated that—unlike the approach to implementing national health insurance, for example, via new legislation—Obama would bypass Congress and instead focus on the EPA’s existing authority to regulate greenhouse gasses under the Clean Air Act. Last, while the speech revealed few details about the means by which greenhouse gas (GHG) emissions will be reduced, the broader memorandum released by the White House in connection with the speech provided very ambitious emissions reduction targets along with a precise timeframe to complete the regulations before Obama leaves office.
While the president’s memo includes several sections on renewable energy, overall the focus is more on capping emissions from existing and new fossil fuel plants than on pushing the widespread adoption of green sources. According to the president’s outline, the EPA will begin the process by issuing a first round of proposals, due September 30, to regulate emissions from new facilities.
However, as few new coal plants are being constructed, the more impactful matter will be the regulation of existing plants, initial proposals for which are due in June 2014.
The president was vague about the regulation of emissions from existing plants, but emphasized the need for a flexible approach to reduce compliance costs, maintain system reliability and enable “continued reliance on a range of energy sources.”
According to analysts, this wording suggests a tacit acknowledgement of natural gas’ lower emissions rates and a willingness to embrace conversions from coal to natural gas for existing plants.
Bullish on gas
The ambitiousness of the reductions targets also supports a bullish outlook on natural gas demand. Obama reiterated his pledge to “reduce America’s GHG emissions by about 17% from their 2005 levels by the end of this decade.”
To hit that objective, GHG emissions would have to be slashed by 730 million metric tons per year, which would require an 18% cut in emissions from the power and transportation sectors (though if industrial sources of GHG emissions are included in EPA regulations, this percentage would fall).
According to Alliance Bernstein’s research, reducing carbon emissions from the fossil fuel fleet by even 10% would require a diminution in utility burn of approximately 175 million tons, or 17% of U.S. coal production, and an uptick of 8 billion cubic feet per day in gas burn, or the equivalent of approximately 12% of U.S. gas production.
Although it appears, at this early stage, that at least the nearto- medium term impact of climate-change regulation will be favorable for natural gas relative to coal, energy investors will need to consider how the EPA’s forthcoming regulations will affect utility demand for these two fuels over the longer term. Investors in the power space, meanwhile, must assess how the specific structure of the regulations will affect their costs. While the impact of new policies could be severe, especially depending on an individual plant’s emissions, power generators may be allowed to recover some portion of their compliance expenses.
Unfortunately for the capital markets, a high degree of uncertainty remains about how all these issues will play out. The Clean Air Act did not explicitly address regulation of GHG emissions, and the EPA is only an enforcer of the act, not a policy-maker. Without Congressional intervention, it will be difficult to achieve the stated policy objectives based on the Clean Air Act alone. Litigation and congressional gridlock are thus likely to play large roles in delaying the implementation of any emissions rules.
While the EPA has in the past tried to use the Clean Air Act for a cap-and-trade carbon regulation system, the D.C. Circuit Court of Appeals has rejected this approach. The outcome of mid-term elections and future judicial appointments for the D.C. circuit, therefore, will be important indicators for investors to watch.
Invest and divest
Buried in the president’s speech was an injunction to college students to continue exhorting their schools to rid their endowments of stocks in fossil-fuel companies: “Push your own communities to adopt smarter practices. Invest. Divest.”
While only several schools have committed to divestment so far, nearly 20 mayors and city councils have made pledges of some sort. However, as not a single university with an endowment exceeding $1 billion has yet agreed to participate, shareholders in oil companies do not have to fret about stock prices being pressured by large sellers, though this is yet another issue to keep on the radar insofar as it provides an indication about the national appetite for future policies.
Tamar Essner is a director of Energy Corporate Solutions for NASDAQ OMX (recently purchased from Thomson Reuters) and can be reached at 646-822-3646 or tamar.essner@thomsonreuters.com.
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