Can Obama's Climate Plan Really Impact Your Portfolio That Much?

As coal plants are slowly dying off, new regulations are being put into place by the Obama administration to clear the air of carbon's residue.

Meanwhile, natural gas is gaining momentum and becoming one of the most efficient and affordable energy resources in our nation. And Tyler Crowe takes a moment to let us in on a secret stock he's been watching, all on today's Industry Focus, energy edition.

A full transcript follows the video.

Sean O'Reilly: We're talking carbon emissions on this energy edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly joining you here from beautiful Fool headquarters in Alexandria, Virginia. To my left is the incomparable Tyler Crowe. How you doing, man?

Tyler Crowe: Doing pretty good. I noticed you didn't say bright and sunny because for the first time in a couple weeks this has been one of the days where it isn't bright and sunny out in Alexandria.

O'Reilly: Oh well. What are you going to do?

Crowe: Oh well.

O'Reilly: Big news this week. We thought we'd change it up for our listeners and not keep talking about oil.

Crowe: But it's so much fun to talk about.

O'Reilly: I know. Big news regarding the coal industry. It's been a rough five or ten years for the coal industry. The Obama administration just came out with some new regulations basically restricting carbon emissions, trying to get CO2 in the atmosphere to be dropped. What do you think?

Crowe: We're a business and investing show so I'm going to try as hard as I can to avoid the political aspects of this. If you look at it, there's a lot of political positioning going on around this. So let's just take that off the table and look at what has been going on in the market as of late.

Starting in 2005 was when carbon emissions in the United States actually peaked.

O'Reilly: So we have been falling since then?

Crowe: We have been falling. We've actually decreased total carbon emissions in the United States by 10% since 2005. A large portion of that has been the fact that in that time frame natural gas has become very cheap, thanks to the shale boom in the United States.

O'Reilly: Correct me if I'm wrong; didn't it peak out at $13 per milli-unit and then it dropped about $2 in 2010?

Crowe: That sounds about right. You were just around peak oil time where natural gas prices were through the roof, then you throw in the financial crisis, and right after that the amount of natural gas that came online was incredible. It's kept prices for natural gas incredibly low for a long time.

Then when you add the fact that coal plants, the things that have been generating power for us for so long, are getting old. We have a very large component of our coal generating capacity in the United States. It's more than 50 years old. As much as we like to think we can keep using that stuff it's old and it needs to get replaced.

O'Reilly: A lot of my energy is coming from coal plants that were built in the JFK administration.

Crowe: Some of them in the Eisenhower administration, actually. EPA does a list of all power plants in the United States and we have power plants that are still working in the United States that were built in the 1950s. We're talking the Eisenhower, Korean War.

O'Reilly: I like Ike and coal power.

Crowe: Exactly. So when you look at that, those things are going to get replaced. They just have to. It's not like a forced mandate where we have to get rid of these coal plants.

O'Reilly: Things break.

Crowe: They're dying, they're breaking, it's getting old. If you look at the options that utility companies have today, from an economic standpoint -- we're not even talking about regulations to a certain degree. I understand there are some implications people are looking at. We could get taxed on carbon or something, or start to see these regulations, but a few years ago that wasn't really the case.

They were still looking at it from an economic standpoint and saying "Instead of building a new coal plant it's a lot cheaper for me to build a wind or gas plant?"

O'Reilly: Everyone knows Warren Buffett's Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) is obviously an insurance conglomerate and that's how it got as big as it did, but an increasingly large percentage of Berkshire's business has been as a regulated utility. Even 10 years ago -- and there are some tax subsidies in there -- but Buffett's got the biggest wind farm in Iowa and he started touching into solar. He's not a dumb man. He's doing it for a reason and it's economics.

Crowe: One thing I really implore anyone who has invested in energy utilities or anything like that; go on a Google (GOOG 0.74%) (GOOGL 0.55%) search and look up the Lazard's (LAZ) Levelized Cost of Energy report. It's a report put out by the research firm Lazard and it goes over the cost per megawatt that it takes to install and operate a new energy generating facility.

It covers everything. Nuclear, coal, gas, wind, solar; and if you look at the ones that are available today...

O'Reilly: Can I get what's most efficient?

Crowe: Go ahead.

O'Reilly: I'm actually going to go with natural gas just because natural gas is $2.78 per million symbol units, I believe.

Crowe: The lowest is -- on the low end of the range -- is wind.

O'Reilly: Wow. That factors in some tax subsidies though, I assume.

Crowe: It does. There's a little bit there, but on wind a cost per megawatt hour of operations and construction is...

O'Reilly: You're making T. Boone Pickens really happy right now.

Crowe: Oh, yeah. I'm sure.

O'Reilly: That Pickens plan.

Crowe: It's $37 per megawatt hour for wind. Using the utility scale, the lowest that solar has is about $72. The lowest natural gas, which is gas combined cycle, is $61, and the lowest for coal is $66. However, the range for coal is immense. It can go anywhere from $66 to $151 depending on coal sourcing and anything related to transportation cost and some of the new technologies they have to put in for carbon capturing.

O'Reilly: Right. Wow. So I was wrong. I wasn't wrong though.

Crowe: You were pretty close.

O'Reilly: I'm pretty happy. That could easily change too if natural gas goes up a little bit. What was that Pickens plan? It was the stretch from Montana all the way down to Oklahoma, the panhandle of Texas was the Saudi Arabia of wind; that huge part of the United States.

Crowe: It is an option. If you look at NOAA, they do some reports on average wind speeds across the United States and if you look from across the great planes there's this immense amount of potential in the average wind speed, making it an attractive option.

When I look at this from an investor standpoint I don't really see it changing the investment thesis that I had two or three years ago. A lot of the coal companies that we've seen have been in financial straits for quite a while, and it's not just because of regulations. They have a lot of legacy cost issues, debt was extremely high because they tried to consolidate at the peak of the market.

If you look at Alpha Natural Resources, they just filed for bankruptcy right around 2011 at the highest of commodity prices. They tried to do a $7.3 billion acquisition and that eventually caught up with them. That's been very difficult for them.

Utility companies have been making these decisions for years. Considering those trends, watching what business have been doing as of late, I don't really see a huge, tangible change that I would make to my investment thesis based on what these regulations have been doing.

O'Reilly: Got it. Before we move on, I want to make everybody aware of a very special offer for all of Industry Focus listeners. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner.

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Now we're playing mailbag with Tyler Crowe here. This is where we have loyal Industry Focus listeners write in.

Crowe: All five of them.

O'Reilly: All five of them.

Crowe: We put them on a rotating schedule.

O'Reilly: Yeah. Actually, a lot of those people that we have that write in, they have names of our co-workers. We don't know why.

Crowe: What a coincidence. This is a real one, people. We're not joking. It's a real one.

O'Reilly: Rob asks: Caterpillar (CAT 0.07%) recently released their quarterly report and in it they announced that they're going to buy back some of their shares. Do you think this was a good call considering the slump they are currently in? What are the reasons companies buy back their shares? Thanks for the input, and I hope to hear back soon. Rob.

Crowe: Well, Caterpillar; one of the things when you look at industrial manufacturers or equipment manufacturers like Caterpillar today, they're in a rough patch now. Not because of the business itself, but more of the economic...

O'Reilly: Macroeconomics. They're out of control.

Crowe: Right. The macroeconomic conditions that you've seen. You have mining and energy companies scaling back capital expenditures at wild paces over the past couple of years. Now with oil dropping off very quickly it has obviously affected revenue, it has affected the bottom line. Caterpillar itself has been trying its best to manage the situation as best as it can. Over the past year it's reduced its headcount by 4000 employees trying to cut costs.

One of things that is encouraging for this share buyback program is the fact that the stock is pretty cheap in comparison to historical records. Right now it's trading at about 13x earnings which is very reasonable when you're looking at doing a stock buyback. If you look at the cash generation situation, at least in this past quarter they did more than enough to cover.

O'Reilly: They were free cash flow positive.

Crowe: They were free cash flow positive. More than enough to over their $2 billion in operational cash flow, about $600 million in expenditures on top of their dividend. There's enough free cash sitting around, a little bit on the books, and management is looking at it now and saying "We can take an opportunity here to reduce our share count, give a bit of value back to shareholders, and give a bump to share prices showing people we have confidence in our business right now and we think there is great value in our stock. We're going to try to create value for our shareholders by doing so."

O'Reilly: Yeah. I was immensely happy when I read that Caterpillar was doing this because Caterpillar, like any other company on God's green earth, has three options of what to do with money. They can pay a dividend, they can invest in operations, or they can buy back stock. That is it. They're currently peeling back on the operations; that's out. China doesn't need as many machines, we're not going for much coal.

They could pay a dividend, but then again, we're all subject to the dividend tax rates. So what's the other option when you're stock is down? Buy back stock. They're doing that at an awesome time. In the last six years since the recession when the Dow gave a high five to 6800 and then came back up; all these companies have been minting money and they're buying back shares at all-time highs, six years into a bull market.

I'm like "Where were you guys six years ago when your stock was at all-time lows? Why weren't you buying back then?" I remember a year ago we were talking about Disney's buyback when they had upped it. Disney was at an all-time high. I'm like "What are you guys doing?"

Anytime I see a company -- and I don't want to plus another energy company -- but Core Labs (CLB) is buying back stock like crazy. They're getting beat up with oil prices. Anytime we see a great business -- which Caterpillar is, and they're probably the world's premier construction machinery company. Correct me if I'm wrong, but it's them and a South Korean company, basically.

Crowe: So there's some John Deere fans out there.

O'Reilly: There's a few out there. I'm sorry, John Deere fans. I'm glad that they're doing this and not just holding onto the money out of fear. I would have been very disappointed had business turned around in one or two years and then they issued a buyback. That would have been absurd capital allocation.

Crowe: One of the things that is critical when it comes to share buybacks; you see companies that do it at a very regular basis like ExxonMobil (NYSE: XOM) who's like "We're just going to do this." One of the questions you raised there was "Why not just do it as a dividend instead?" When it comes to share buybacks you can be a little bit more opportunistic with your buyback.

When times are not as great and you may be a little strapped for cash you don't feel as obligated to buy back stock. Like you said, there's some opportunity loss when you have really low share prices, but at the same time, when you cut a dividend there is a market reaction and a general thought around your company that things are getting really...

O'Reilly: "What are they hiding?"

Crowe: Really in trouble. We, in the United States, really like to see that constant dividend every quarter. I know some other companies in Europe like to do it as a variable rate of like 25% of net income.

O'Reilly: Why do European companies just do one big one every year?

Crowe: In the United States we have that expectation: that dividends will be rock solid, and they will grow. If you were to cut that, that would look worse. You need to manage that 'how high can I keep my dividend'. It will either be maintained, or grown at a certain rate. Then if I get a little extra to play with in the margins, share buyback is a great opportunity.

The only thing that I'm really hesitant about when it comes to share repurchases with a company is, it has to actually reduce total shares outstanding. That is the only way that share buybacks actually deliver value to an investor over the long-term.

O'Reilly: You don't like it when tech companies buy back the shares that get issued because of stock option grants all the time?

Crowe: Yeah, I'm going to buy back a ton of shares and then I'm just going to give them back to my employees in some sort of compensation package anyways. That's the issue at hand. You don't want to take something from shareholders and then give it back to your employees with huge stock compensations.

The point of the share buyback and the reason it creates value is because it increases the earnings per share for everybody involved, it increases your slice of the pie in that business. Another benefit, if it's also a dividend payer it allows the company to either reduce its total dividend payment.

O'Reilly: It saves costs.

Crowe: It does save costs, but at the same time they can keep that dividend payment constant and slowly bump the per-share dividend because of the reduced share count. Those are the ways that reduced shares can increase value for a company long-term. As long as the share count is going down, that's the encouraging sign more than anything else.

O'Reilly: Awesome. Very good. Well, thanks again for writing in Rob. If you are a loyal listener and have questions or comments we would love to hear from you. Just email us at [email protected]. Again, that's [email protected].

Crowe: It would be nice to have one mail bag question every day. As a dedicated segment.

O'Reilly: We know you're out there, five people. Please write us some questions.

Crowe: Send them. All five of you. We'll do you on a rotation.

O'Reilly: In fact, we were talking about how we'd love to do a mailbag show.

Crowe: A whole show. It would be great.

O'Reilly: Just tons of questions. This oil stock. Anyway. Before we leave I did want to get your thoughts on energy stocks on your radar because that sector's been so beaten up it's like "Is it time to go shopping yet?" What are we doing?

Crowe: This is the "Am I crazy" moment. I've been watching this one energy stock for a while -- Denbury Resources (DNR), stock ticker DNR.

O'Reilly: They're the CO2 guys, right?

Crowe: They are a specialist in enhanced oil recovery using CO2. Basically they inject CO2 into old, mature wells. Basically wells we drilled and produced oil from 20 or 30 years ago and going back and saying "We can get this much more out of there."

O'Reilly: Have they ever injected CO2 into Drake's well in Pennsylvania?

Crowe: I do not believe so.

O'Reilly: I'm joking.

Crowe: That would be interesting to see if there was anything there, just as a fun test.

O'Reilly: I visited it with my friend on a road trip 10 years ago and it still produces 10 barrels a year.

Crowe: That's pretty cool. Getting back to Denbury itself, one of the things that was really encouraging -- despite its massive sell-off after earnings report yesterday -- it has slashed its capital budget, it has more flexibility to do so because the decline on enhanced oil recovery wells is much lower.

It can scale back a lot more and not see the production declines like we've seen with other companies. Also, one thing that was encouraging was they actually brought in enough operational cash flow to cover both their capital expenditures and their dividend.

O'Reilly: So they're still paying one?

Crowe: They're still paying a dividend. At current yield it's 9%, which would scare a lot of people, but when I look at this company they've got pretty strong hedging protection for the next couple of years. So it can weather a storm for quite a while. It has a very clear plan of what it wants to do in terms of production growth because they have to plan it years in advance for these CO2 operations.

When I look at this, they haven't taken on a lot of the debt levels that some of these other leveraged, independent oil companies.

O'Reilly: Do you know offhand what their debt to assets is at all?

Crowe: I believe debt to capital is somewhere in the low 30s. That's much better than we've seen with a lot of companies.

O'Reilly: Yeah. Even some of the better ones are in the high 40s. That's actually pretty respectable.

Crowe: Reasonable debt profile, they can certainly manage it with the EBITDA. When I look at this company I keep looking at it going "What am I missing?" I'm probably going to look at this thing a little bit more, but based on what I've seen so far I'm kind of befuddled as to why the market has treated it so poorly.

O'Reilly: Everybody's scared right now.

Crowe: I guess so.

O'Reilly: I do want to mention before we leave, you really turned me on to the pipelines because they're the last Bastian of owning a monopoly in America.

Crowe: We're on to Sean's pick here, by the way.

O'Reilly: Sorry, everybody.

Crowe: Sean's pick for the week.

O'Reilly: They've got that 5.5% yield, they've sold off from 40 down to 27.

Crowe: Who's "they", by the way?

O'Reilly: Enterprise Products Partners (EPD 0.48%).

Crowe: There we go.

O'Reilly: You're a bad host.

Crowe: I'm not a good host, that's why you ask me the questions. We reverse the roles and I don't know what to do.

O'Reilly: It's fine. As I recall, they have the largest natural gas liquids pipeline system in the United States. They still ship the crude, they still ship natural gas and their profit margins are pretty much guaranteed by the regulators. It seems silly this thing would sell off like it has.

Crowe: Can't argue with that.

O'Reilly: Amen. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe, I'm Sean O'Reilly. Thanks for listening, and Fool on!