Five Points Advisors, LLC

On Thursday, October 7, 2010, I had the pleasure of participating in a round table discussion coordinated by Our Green Value and the Green Chamber of the South. Other participants included Jill Stuckey (Georgia Department of Economic Development); Nathan McClure (Georgia Forestry Commission); Bill Moore (Moore and Associates); Bill Garvey (Athens Paper Company); Bill Blair (Print Direction); and Stephen Schrock (Morris Manning & Martin). The discussion centered on the future and sustainability of Georgia’s forests. Each participant addressed different factors affecting Georgia’s largest natural resource and industry and the discussion was enlightening and informational.

Perhaps the most interesting take away for me was the revelation that a large part of Georgia’s biomass strategy for the future does not involve forest products. Furthermore, the strategy does not focus on power generation. Rather, the plan is geared towards creating enormous crops of Miscanthus and focusing on biofuels (cellulosic ethanol) rather than wood pellets for power plants. This was a surprise to me and several other participants as much of the press is centered on co-fired power plants and the export of wood pellets to Europe for power generation purposes.

Miscanthus is a perennial (farmers need only plant it once every 10 years or so) that is typically used as an ornamental grass in Georgia. It grows quickly and is tolerant of dry weather conditions and less than optimal soils. Its extensive and deep root system reduces the need to irrigation and fertilization. All of these qualities make it a great biofuel option and many hope that it will be the backbone for a cellulosic ethanol industry in Georgia. Jill discussed the possibility of generating up to 35 billion gallons of ethanol from crops of Miscanthus in Georgia. Such a lofty goal would require enormous investment and a reallocation of cropland and forestland, but could be achievable.

Once again, Duke Energy CEO Jim Rogers is calling for Democrats to pass legislation that includes putting a price on carbon. The link below will take you to a Bloomberg article covering his latest comments.

http://bit.ly/dljCTA

I recently had the opportunity to hear Jim Rogers, Chairman and CEO of Duke Energy Corporation, talk about his company and his views on carbon legislation.  Mr. Rogers is a vocal and ardent supporter of legislation that addresses carbon emissions.  His rationale is quite rational.  Set aside the arguments for legislation that are rooted in the hotly debated climate change research and science and Mr. Rogers is still a supporter.  Why?  Power companies, like Duke Energy, need guidance.  Over the next 50 years, Duke Energy will need to retire and replace its entire fleet of power generation facilities, representing billions of dollars of investment.  They are ready to start now and need guidance from the government on how to allocate these dollars.  If Duke Energy is going to be required to decarbonize its fleet, they need to begin planning for that now.

Mr. Rogers characterizes the various fuels for power generation (coal, natural gas, nuclear, hydro, solar, wind, and biomass) with three qualities:  affordability, reliability and environmental impact.

Coal, which fuels 50% of electricity in the US, is affordable and reliable, but has a tremendous negative impact on the environment.

Natural gas has had a storied past with respect to affordability and is a reliable fuel source.  Its environmental impact is debatable.  From a carbon standpoint, it has 50% of the carbon footprint of coal, but the new technologies for extracting natural gas have yet to be fully vetted.  New drilling techniques have opened up enormous potential supply of natural gas, but those techniques may have adverse impacts on another precious resource, aquifers.  Additionally, while the carbon footprint is substantially smaller than that of coal, under the proposed legislation, the carbon reduction offered by switching to natural gas would fall short of the required reductions.

Nuclear energy is reliable and clean, from a carbon footprint standpoint, but is very expensive.  It also presents security risks and you still have to deal with its by-products.

Solar power, as with other renewables, is clean, but is very expensive and not reliable.

Wind power is clean, very expensive and not reliable.

Biomass is clean, somewhat expensive and fairly reliable.

With this backdrop, a possible path to a cleaner power generation infrastructure is migrating to cleaner coal plants in the short run, supplementing that base load generation with renewables and natural gas.  Ultimately, we could power our nation through a mix of nuclear, natural gas and renewable power sources.  It won’t happen over night.  If it is going to happen, there must be guidance and leadership in Washington D.C. to compel the change.  We’ll see what happens with the latest rumor/news that a utility-only version of the energy bill will be introduced to the Senate in the coming weeks.

With the continuing ups, downs and hairpin turns of the carbon legislation rollercoaster taking another gut-wrenching jolt today, I wanted to conduct a brief analysis of the impact addressing carbon emissions has had on publicly traded companies.

The Chicago Climate Exchange launched its voluntary cap and trade program in 2003 requiring its member companies to reduce their emissions by 6% over an eight-year period, 2003 – 2010. The baseline for measuring the reductions is an average of annual emissions from 1998 to 2001. While the program is voluntary, it is legally binding as the companies that join are contractually bound to meet their reduction commitments and the results are verified through reputable third party companies.

For the purposes of this analysis, I chose the ten largest publicly traded U.S. companies from the CCX’s 350 members. Ordered from largest to smallest in terms of market capitalization, the list consists of an interesting mix with many key industries represented: banking, technology, manufacturing, automotive and chemicals.

To measure the impacts of reducing carbon emissions by 6% from their respective baselines, I chose a simple and practical parameter, stock price performance. My thought is that investors will take into consideration the financial health of each of these companies by analyzing cash flows, earnings, the strength of balance sheets, market position, growth strategies, etc. and make their purchasing decisions with all these factors, and others, in mind. I measured the stock price performance for the period 1/2/03 to 3/31/10 for each of the companies using the adjusted closing price from Yahoo! Finance, which captures the effects of dividends. I also measured the growth of the Dow Jones Industrial Average over the same period. HIP Investor guru, R. Paul Herman, suggested that I also include industry-specific indexes in my comparison, but for the purposes of this analysis, I stuck with the Dow.

The results were not that surprising to me: eight of the ten companies outperformed the Dow Jones Industrial Average. To me this suggests that other companies with talented and visionary management teams would be able to lead their companies through the challenges that carbon legislation may present. The majority of these companies have flourished despite their proactive steps to improve energy efficiency and reduce their carbon emissions.

The Results

The following article discussing opposition to cap and trade legislation in New Mexico highlights many challenges to addressing negative externalities, such as pollution or climate change.

Article: http://bit.ly/a19O71

In particular, the article touches on the theme of forgoing action on the grounds that a particular stakeholder, or in this case the State of New Mexico, does not pollute as much as other states and therefore its efforts to curb carbon emissions will not be that effective in the absence of broader participation. On a national level, opponents to cap and trade pose a similar argument: without the participation of China and India, a U.S. program will not have sufficient impact.

If we are to address the externalities created by pollution, all stakeholders should take the appropriate steps. New Mexico’s participation in the Western Climate Initiative could apply pressure on the U.S. government to pass legislation. Moving forward with a regional cap and trade program, similar to the Regional Greenhouse Gas Initiative in the Northeast, could provide an additional example of a group of states making positive steps towards lowering carbon emissions without crippling their economies. On a larger scale, if the U.S. passes carbon legislation that puts us on par with Europe, the additional pressure may compel China, India and other developing economies to enact similar legislation.

Given the nature of state, national and global politics, we can’t really wait for everyone to get on board before taking action.

Obama’s tenacity with respect to the healthcare legislation was noteworthy. He promised healthcare reform while campaigning and worked at it relentlessly until he got something passed. Whether or not the proposed legislation is close to his ideal is another question altogether.

That being said, it appears that Obama is trying to shift his focus to an energy plan for the U.S. With a new set of nuclear plants going up across the country and with today’s offshore drilling announcement, it appears that Obama is making an effort to reduce our dependence on fossil fuels in the long term and reduce our dependence on foreign oil in the short term. These efforts might also be viewed as concessions to opponents of cap and trade legislation. Hopefully, Obama will hold fast to the concept of Cap and Trade as a key component for helping the U.S. achieve energy independence. The Clean Air Act was effective at combatting acid rain in the 90s using the Cap and Trade model and it should serve as an example of how legislation can have a positive impact at addressing negative externalities, like acid rain or climate change.

For more on today’s drilling announcement, here’s an article:

http://bit.ly/9XcDmY

For details on proposed new nuclear plant sites:

http://bit.ly/cXIvTs

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