An Investor's Guide to the EPA's New Rule: Will Coal-Heavy Utilities' Dividends Disappear?

The EPA's recent proposal to regulate carbon emissions from existing power plants means big changes are coming to the American energy space. Here's what investors need to know.

Jun 10, 2014 at 9:40AM

Building

Source: pixabay.com.

The Environmental Protection Agency's proposed new rule on carbon emissions from power plants got the response that many would expect: One half of the populous sees it as championing the environmental cause, while the other half protests it as a job killer. While this new plan (requiring carbon output from U.S. power plants as of 2030 to be 30% below 2005 levels) raises many questions, the biggest for investors is how it will affect certain companies. Let's look at four utilities that have sizable coal generation capacities -- Duke Energy (NYSE:DUK), Southern (NYSE:SO), American Electric Power (NYSE:AEP), and Dominion Resources (NYSE:D)-- and how their business operations will be impacted by the new rule.

What do the changes mean?
First, remember that this is only a proposal so far. No regulation has been enacted, and there is likely to be some heated -- and possibly entertaining -- political theater headed our way. However, if instituted the rule would demand a 30% reduction in carbon emissions produced per megawatt-hour of power produced in the U.S. Today the average megawatt hour produced in the U.S. emits 1,768 pounds of carbon-dioxide equivalent, so that means the suite of generation capacity needs to be less than 1,237 pounds of CO2 equivalent by 2030. 

The EPA has indicated it will let each state determine how it wants to meet that goal. It could involve retrofitting older coal plants with carbon capture equipment, switching to natural gas -- which on average emits 800-850 pounds of CO2 equivalent per megawatt-hour -- or installing enough alternative energy capacity to offset emissions from existing facilities.

This plan is likely to lead to the decommissioning of several additional coal-fired power plants. Even before the EPA proposal was unveiled, almost 30% of the nation's coal facilities were either set or being considered for retirement due to emission regulations covering sulfur dioxide and mono-nitrogen oxides. If carbon emission regulations are added to that mix, it's not hard to see companies either completely walking away from coal plants or converting them to burn natural gas, rather than retrofitting with pollution control technology.

Main

Source: U.S. Energy Information Administration.

Business as usual
By the looks of the current generation capacity of all four of these utility companies, the move away from coal started a while ago. While a large percentage of the Duke, Southern, and American fleets still have coal as their dominant generation source, most of those investments were made decades ago and the percentage of retiring coal facilities is considerably higher than the national average.

Company Total Coal Power Generation (% of fleet) % of Coal Power Stations Slated to Retire Before 2020 % Remaining Coal Power Stations Greater Than 40 Years Old
Duke Energy 24,056 MW (35.7%) 19.4% 35.3%
Southern 18,494 MW (33.4%) 18.5% 57.5%
American Electric Power 12,215 MW (74%) 31.2% 36.7%
Dominion Resources  7,287 MW (25.4%) 14.5% 60.2%

Source: U.S. Energy Information Administration.

By the time that each company's set-for-retirement plants go offline by 2020, another large chunk of facilities will be more than 50 years old and reaching the end of their economic lives. Let's assume that these facilities go offline by 2030, when the EPA hopes to meet its emission reduction target. With the exception of Duke -- which will have 55% of its coal facilities out by then -- these companies would see more than two-thirds of their current coal generation capacity come offline.  

The utilities' plant proposals also suggest there is not much in the way of new coal facilities coming online. Both Dominion and American Electric have no new coal power plants in the works, while Duke and Southern have about 7 gigawatts of coal facilities planned or under construction. A large portion of that will come from the two companies' coal gasification facilities, which extract hydrogen and methane from coal without burning it to make for a cleaner combustion process. Based on the estimates from the two companies, the new plants will more than adequately fall under the EPA's emission guidelines, though these facilities come at exuberantly high prices.

Based on the levelized cost of energy, coal in general is quickly losing out to other fuel options. This image from fuel cell manufacturer FuelCell Energy describes the levelized cost of energy for various power sources, which is a way to give an apples-to-apples comparison of each power generation source based on construction and operation costs. In many cases, using combined cycle natural-gas turbines for base-load power, or some renewables for peak-load power, are less on a per kilowatt-hour basis than coal. Also keep in mind that these energy costs do not include alternative energy credits or other tax subsidies for alternative energy.

Lcoe Fcel

Source: FuelCell Energy.

Granted, solar and wind may not be the best choice for power generation for these utilities, since they are mostly located east of the Mississippi River. But considering how rapidly the cost of solar and wind technology has declined in the past several years, they could become more viable options for all of these companies when they turn over their generation fleets.

What a Fool believes
Often overlooked with rules like the new EPA proposal is the long time horizon for enactment. The EPA plan comes with a 16-year window to reduce carbon emissions by 15% from today, so it might not be as hard as some people may suggest. Regardless of the EPA plan, Duke, Southern, American Electric, and Dominion were all likely going to need to turn over a very large portion of their coal fleets because of age. So this regulation probably won't add too much pain and frustration. In fact, decreased energy consumption through conservation and market-share grabs from unconventional power companies are greater threats to the four utilities' overall business model. If you are invested in these companies, there is no need to panic simply because they have large coal fleets -- addressing that over the next 16 years won't be a huge issue. Instead, watch how these companies address -- or hopefully embrace -- these new competitors. The overall decline in regulated utility demand will dictate the future of these companies.

Do these utilities have what it takes to make our list of top dividend stocks?
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see if Duke, Southern, American Electric, or Dominion made the cut in our free report on these stocks, just click here now.

Tyler Crowe has no position in any stocks mentioned. You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

The Motley Fool recommends Dominion Resources and Southern Company. 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.

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