Cap-and-trade bill to cause bigger disparity in energy sector

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The work by the Senate earlier this month in considering the passage of the Kerry-Boxer climate and energy bill represents a first step towards limiting greenhouse gas emissions. But for energy and power companies, it’s the first official dividing line between those who will turn a profit several times over and those who will be forced towards alternative energy for mere survival.

The bill sponsored by Rep John Kerry (D-MA) and Barbara Boxer (D-CA) follows the passage of the House of Representatives’ version of the cap-and-trade bill last June. Rep Henry Waxman (D-CA) and Rep Edward Markey (D-MA) first sponsored the cap-and-trade bill in the House last year under the American Clean Energy and Security Act of 2009, the “Climate Bill.”

But competing Senate bills are holding up legislation currently. At issue is the number of free allowances or permits given out to companies to emit a certain quantity of carbon.

Have and have nots

The way the allowances are distributed determines who will be the winners and losers under the final cap-and-trade legislation. “Since 50% of the free allowances come from historic emissions and 50% comes from electricity delivered, a public utility like Exelon (NYSE: EXC, BBB/Baa1) will have a windfall on the free allowances,” said an industry lawyer. They will get much more free allowances in the early years of the program than they will need for compliance purposes, he added.

Exelon, whose power generation portfolio is at about 70% nuclear, said it will benefit between USD 1bn to USD1.1bn from the cap-and-trade program, William Von Hoene, Jr, executive vice president for finance and legal at Exelon told this news service.

Point Carbon, a statistical research provider, said Exelon, however, would see a net gain of more than 36% of its operating income or about USD1.7bn from the final cost of carbon. But Von Hoene refuted the Point Carbon tally at a conference earlier this month. Point Carbon uses an average price of carbon of USD 15 for the first few years of the cap-and-trade program.

The inability to pass on costs to customers will hamper some companies, while others may not adapt quickly enough to new alternatives. Regulated utilities that are coal heavy and unregulated merchants that are focused primarily on coal may not be able to recover all of their costs, said two industry lawyers and a credit analyst.

US credit ratings have yet to be altered due to the program. Yet, where a company is located will play a part in any changes to credit profiles in the future. A coal plant in Texas will be affected much more than a coal plant in Illinois or Ohio due to how the prices are already set in those markets, said Swami Venkataraman, director at Standard and Poor’s.

“Our economic models say companies that operate in the SouthEast and in the MidWest in coal are in trouble,” said the first lawyer. “The cost of carbon starts dictating the economics, whether it means to shut down a plant or not,” he added.

Merchant generation companies will compete against each other due to the varying ability to pass through price increases to customers, said the second industry lawyer. Dynegy (NYSE:DYN, B/Caa1), NRG (NYSE: NRG, BB-/Ba3), and Reliant (NYSE: RRI, B+ /B1) will be competing with other companies making similar investments in changes, he said.

But California utility PG&E (NYSE: PCG, BBB+ /Baa1) has a foot in the carbon offset market already since they started their program two years ago, said Emilie Mazzacurati, head of Point Carbon’s North American research division. However, it is unlikely the California utility commission will let them pass on additional costs to the consumer.

Florida Power & Light (NYSE: FPL, A/A-) is on Mazzacurati’s and other industry participants’ radar lists as benefiting from the proposed legislation due to their wind and nuclear exposure. Progress Energy (NYSE: PGN,BBB+/Baa2) and Ameren (NYSE: AEE, BBB- /Baa3) should also have a slight buffer from losses due to their coal merchant allocation, she said.

Offsetting costs

Southern Co (NYSE: SO, BBB+/A3), American Electric Power (NYSE:AEP,BBB/Baa2) and Duke Energy (NYSE:DUK,A-/Baa2) were cited as having the most exposure to losses under the Kerry-Boxer bill, according to a report earlier this month from Point Carbon. Southern’s operating income was considered the most sensitive to the cost of carbon at a loss of 12%, followed by American Electric Power and Duke.

While Southern would not comment on the specific hit of the cap-and-trade bill to its operating income, the company said it is working with Congress now to try and mitigate those costs to customers that will be passed on, according to a spokesperson. AEP, which supported the Waxman-Markey bill, said there are opportunities to offset cap-and-trade programming so that reductions can be made, said an AEP spokesperson. The company is looking for ways to reduce its costs to customers, she said.

AEP said the company is making investments in carbon capture and storage equipment for its power plants as well as additional investments in renewable energy. Southern is constructing two new nuclear units.

Similarly, Duke Energy has been trending in the direction of renewables but the average fleet of generation that they have is coal, said the second industry lawyer. Other companies have seen aggressive plans for wind projects falter since they haven’t had enough cash flow from existing coal assets to put into the projects, added S&P’s Venkataraman.

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