Utility Stocks Face Trouble from New Rules

Good news for your health... bad news for utilities.

Today President Barack Obama will propose cutting greenhouse-gas emissions from U.S. utilities by 30 percent compared to 2005 levels. The new standards would take effect by 2030, and individual states would have leeway to set specifics parameters. Utilities would presumably be able to chose from a combination of shifting towards renewables, upgrading existing plants and even participating in a scaled back cap-and-trade carbon credit program administered by states.


As Bloomberg Founder Michael Bloomberg writes in his Bloomberg View Editorial today:

We have waited a long time for the EPA to take action. In 2003, a number of states and cities (including New York City) filed a lawsuit arguing that under the Clean Air Act, the EPA had both the authority and the responsibility to regulate carbon dioxide emissions, because they present a clear danger to society. In 2007, the U.S. Supreme Court sided with us. Since then, the challenge of climate change has only grown more urgent, and the cost of inaction more dire.

Today's proposed changes to the nation's emissions standards effectively put coal in the cross-hairs. Coal accounts for 39 percent of U.S. electricity generating capacity, and produces twice the carbon emissions of natural gas powered plants, according to the Energy Information Administration.


The Environmental Protection Agency estimates cutting emissions by 30 percent would produce aggregate health benefits to U.S. citizens of $55 billion to $93 billion in 2030. While we recognize such estimates are pro forma at best, we are even less certain what the proposed changes would mean for utilities seeking to comply with new rules. For better or worse (we argue "for better") this is unchartered territory.


Utilities are the best performing sector in the S&P 500 Index this year, up 11.5 percent compared 3.8 percent for the broader market. The group has mirrored bonds' outperformance, since utilities fund operations with debt and Federal Reserve Chair Janet Yellen has suggested continued "accommodation" for longer than many had forecast.

We question whether utilities can continue to lead in an environment where Washington wants change -- big change. We also note the group trades at a forward price-to-earnings multiple of 16.1 (only slightly less than that of the market) and yet with significantly more scrutiny from regulators. We are inclined to sell utilities.


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