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Why Investors Shouldn't Abandon Duke Energy Corp

By Joseph Wilborn - Mar 31, 2014 at 12:18PM

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Duke Energy's environmental damage not likely to damage the company.

Recently, a North Carolina judge ruled that Duke Energy ( DUK 2.28% ) must clean up its coal ash spill -- the third largest in state history -- which contaminated the Dan River.

Investors should rightly consider how this might affect the company and its growth. However, there is no current indication that the environmental disaster, despite its damage to the ecosystem, will inflict any lasting harm on the company.

Let's consider two primary reasons for this. First, any federal monetary fines are unlikely to be large enough to affect the company's bottom line. Second, any state penalties are also unlikely to cause any long-term negative effects.

Little chance of a big penalty
We can get a rough idea of how much, or, more accurately, how little money Duke might have to fork over to the federal government by examining what happened to other energy companies that were caught polluting.

The largest fine for water pollution on record was issued earlier this month when the coal company Alpha Natural Resources (NYSE: ANR), which last reported $4.95 billion in total revenue, was ordered to hand over $27.5 million. The federal government will receive half, and three states will divide the other half. The company will also have to spend an additional $200 million on equipment to reduce toxic discharges into waterways.

At first glance, someone might argue that those legal issues are the reason Alpha is trading near the lower end of its 52-week range, but Peter Ward, senior equity research analyst with the investment bank Jefferies, attributes the drop not to pollution fines, but to Alpha's large acquisition of low-quality assets.

The largest overall environmental settlement on the U.S. Justice Department's books is with American Electric Power ( AEP 1.27% ), which last reported $15.36 billion in annual revenue. The utility was slapped with a federal air pollution lawsuit in 1999, and when the dust settled in 2007, it had agreed to install $4.6 billion worth of pollution fighting equipment, pay $15 million in fines, and provide $60 million for environmental cleanup and repair.

How is American Electric doing today? Zacks Equity Research rates it a Buy, citing an impressive fourth quarter 2013 report, and a large liquidity position. The research firm considers it in prime position to benefit from the domestic shale boom. 

So, what do the experiences of Alpha and American Electric suggest for Duke? Duke, with its $24 billion in revenue, should easily be able to absorb far more in fines than both the smaller Alpha and American Electric, and still maintain strong attraction for investors.

Home court advantage
How much trouble could Duke be in on the state level? Probably, not much. Consider the background to the story.

First of all, the governor of the state since 2013, Pat McCrory, was a longtime executive with Duke, which is based in his state; according to a state ethics form, his portfolio still includes Duke stock. Several of his political appointees also came from Duke.

Then, last year the state and Duke signed an agreement that requires Duke to pay only small fines for any spills related to its coal ash dumps. However, the agreement did not hold Duke responsible for cleaning up those dumps.

Meanwhile, Governor McCrory's a new appointment to head the state's environmental agency, the Department of Environment and Natural Resources, publicly said in a published letter to the editor of the News & Observer of Raleigh that he sees the agency not so much as a watchdog but as a partner with the companies his agency is designed to regulate.

How friendly has North Carolina been to Duke Energy?
The Associated Press reports that environmental groups targeted Duke three times in 2013 in an effort to force the company to clean up its coal ash ponds. The first time was regarding Duke's Asheville Steam Generating Plant.

In January 2013, the Southern Environmental Law Center filed a notice with intent to sue Duke under the federal Clean Water Act. The Clean Water Act includes a provision by which state regulators have a 60-day window in which to take action that thus stops the federal intervention. On day 58, the state filed the necessary papers to take over the case.

Weeks later, the SELC acted again, this time filing notice against Duke for its coal ash at its Riverbend Steam Station in GastonCounty. Again, the state filed its papers. It blocked the federal government's investigation on the 60th and last eligible day.

The third time came on June 19 when the SELC tried to sue over Duke's coal ash problem at its Sutton Power Plant. North Carolina, once again, claimed jurisdiction, filing its papers on the 60th day.

The state then went a step further and filed notice regarding all of Duke's remaining state coal ash sites, meaning that no federal action can effectively be taken specifically under the Clean Water Act.

Will North Carolina ever get tough with Duke?
This month, one day after the AP published an article exposing the favorable 2013 deal that the state had made with Duke Energy over its coal ash pollution, the DENC asked a judge to scuttle that deal.

The governor then made public his plan for a new task force within the DENC to evaluate all of Duke's coal ash sites in the state.

However, a senior attorney for the SELC told the AP that the recent stance the state has taken against Duke is only for show.

Worry or not worry?
Any investor is wise to pay attention to news related to a prospective investment. And, no doubt, Duke's troubles may be spooking some potential investors. However, anyone investing for the long term should take into consideration that the environmental enforcement track record of both the federal government and the state of North Carolina gives no indication that Duke will suffer any serious lasting financial harm.

 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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