Cleaning Up With 'Socks and Knocks'

One of the media's favorite themes is that the Bush administration refuses to clean up the environment because it is in bed with the energy industry.

But in fact, the Bush administration is about to require the electric power industry to spend a whopping $40 billion over 10 years to install equipment that significantly cuts the airborne pollution emitted by coal-fired power plants, perhaps 700 in all, that are a key cause of numerous medical and environmental maladies.

As much as environmentalists are unhappy with this new federal initiative because they don't think it goes far enough in reducing the sulfur dioxide, nitrogen oxide, and mercury coming out of coal-fired generators, utilities argue that the rule goes too far.

Assuming that spending on equipment to reduce airborne nasties does occur, it could spell opportunities for investing in the companies receiving all those orders.

Before investing any money, though, Fool readers should understand clearly that if the power industry prevails in its court challenges to the initiative, the huge amount of money expected to be spent primarily on reducing what the industry commonly calls "socks and knocks" might not get spent. ("Socks and knocks" is a word play on the symbols for sulfur dioxide and nitrogen oxides, SO₂ and NO_x, respectively.)

Scrubbers and SCRs
That said, the odds would seem to favor utilities being forced to pay largely for two kinds of equipment: flue gas desulfurization systems, commonly known as "scrubbers," for sulfur dioxide; and selective catalytic reduction systems, or SCRs, for nitrogen oxide.

Some utilities have already announced their intentions. According to published reports, American Electric Power plans to install 10 scrubbers by 2010, while Cinergy reportedly will buy equipment worth more than $300 million to be installed in three plants.

Investors in these and other utility companies shouldn't fret, however. The odds also favor states' utility regulators permitting companies under their jurisdiction to recoup these expenditures from customers. (Heads up, all you Midwesterners: Because you get your electricity largely from coal, your electric bills are probably going to go up a fair amount in the coming years.)

$4 billion a year starting in 2006
I communicated with a few industry experts who estimate that, starting in 2006 or 2007, coal-using utilities and other generators will start paying about $4 billion a year every year for a decade or longer. There are actually two federal initiatives at work here. The Clean Air Interstate Rule puts a cap on SO₂ and NO_x emissions that move across state boundaries in the 28 Eastern states where most coal-fueled electricity is generated. The rule is intended ultimately to reduce SO₂ emissions in the region by more than 70% and NO_x emissions by more than 60%.

A separate rule, the Clean Air Mercury Rule, is national in scope, but its financial impact won't be as great because, at least initially, the SO₂ and NO_x equipment is expected also to help utilities comply with required mercury reductions. In the longer term, the mercury rule will probably require significant emitters to spend more if the federal government's goal of 15 tons per year of mercury emissions by 2018, compared with close to 50 tons a year currently, is to be met. (Equipment to meet this stringent requirement is still largely under development.)

While several companies stand to profit by supplying the needed pollution-control equipment and/or related services, the two that perhaps will benefit the most are the Babcock & Wilcox unit of McDermott International (NYSE:MDR), and Alstom Power. After that comes a number of firms, including Hitachi (NYSE:HIT), ADA-ES (NASDAQ:ADES), URS (NYSE:URS), ABB (NYSE:ABB), and Black & Veatch.

A mixed bag
From an investor's point of view, these firms represent a very mixed bag, each requiring its own analysis. Babcock & Wilcox's parent, McDermott, is a services and equipment provider for oil wells, while Hitachi's diversified mix of products ranges all the way from power generation to consumer electronics. ADA-ES is a purer play, the company being focused on environmental technology and specialty chemicals. URS is a global engineering design firm, while ABB is primarily into environmental and automation technologies for utilities and industrial firms.

Other companies mentioned as potential winners include KFx (AMEX:KFX) and Environmental Elements (NASDAQ:EECP). They are probably the two purest plays. KFx provides services and technology solutions that allow electrical generators to run more efficiently and with fewer emissions. Environmental Elements supplies and maintains air pollution control systems designed to let customers operate generating facilities within specified regulatory limits.

Interestingly, some of the utilities that will have to pay out could wind up paying themselves. American Electric Power and FirstEnergy are among the outfits that have invested in a private company called Powerspan, which is working on equipment that reportedly would be able to do it all -- reduce socks, knocks, mercury, and more.

Bill Paul is a former Wall Street Journal and CNBC energy and environment reporter. He does not own stock in any of the companies mentioned. The Motley Fool is investors writing for investors.