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Energy Policy Under President-elect Biden and Divided Government

Since climate policy is a priority policy issue for the Democratic Platform, so too is energy policy.  While there is a lot of back and forth and uninformed punditry about what a Biden presidency would mean for energy policy, our best clue is draft energy legislation issued by the House Energy and Commerce Committee this past January.  Summarized below are the main components of the CLEAN Future Act which is based on an extensive and serious process including testimony from all interested parties taken in fifteen separate hearings throughout most of 2019. CLEAN stands for Climate Leadership and Environmental Action for our Nation’s future.

Now is when investors will see the shift from campaigning to governing.

What is NOT in the draft and what the draft is not.

The draft does not ban fracking or specifically target the elimination the fossil fuels industry. In fact it proposes R&D spending and expanded tax incentives for carbon capture and sequestration (CCS) from fossil fuel users. This is analogous to how the Clean Water Act and the Clean Air Act (both enacted in 1970) made great strides in reducing pollution; not by shutting factories, but by eliminating or capturing their pollutants prior to them being released into the air or water.  The bill is, in fact, technology neutral.

There are provisions to regulate any impact that fracking has on drinking water (which is not the problem with fracking) as well as regulating the water that is brought to the surface by shale production (which is a problem in some areas because of radioactivity), but relative to COVID, will probably have a small impact as the industry continues to build better water treatment infrastructure.

This is not the Green New Deal which is mostly a list of society’s ills which it then connects to pollution in general and climate change in particular touching on issues as diverse as family farming, hazardous waste, nutrition, infrastructure and oh yes, carbon pollution.  The Green New Deal (HR 109, 116th Congress) is aspirational and not actual policy, it is a resolution.  It has far more adjectives than numbers and uses verbs like mitigating, identifying, promoting and ensuring.  Nonetheless, it attempts to broaden support for clean energy by tying together national policy goals that are already being pursued and for which political constituencies already exist.

What IS in the Draft and what does it mean for energy investing?

The Clean Future Act has the following sections:

Title I:       National Climate target

Title II:      Power Sector

Title III:     Efficiency

Title IV:    Transportation

Title V:     Industry

Title VI:    Environmental Justice

Title IV:    Super Pollutants

Title VII:   Economy-Wide Policies

 

Right up front, the draft bill targets zero net greenhouse gas emissions by 2050.  This objective is pretty much the standard for all the OECD countries and an increasing number (ten at last count) of our states as well as numerous (200 at last count) localities and is consistent with emission reduction plans already articulated by most electric utilities.  Because that is the target, the legislation empowers various agencies like the Department of Energy and the EPA to measure and enforce the goals required to achieving this objective.  Like most successful federal legislation, it empowers the states to do much of the heavy lifting, in fact in some respects the language implies the states are actually responsible for laying out and achieving their own plans to achieving the 2050 target.

Impact on Energy Infrastructure Investing

As investors in energy infrastructure (poles & wires and pipes & tanks) the role of the states and Title II (relating to the Power Sector) are the most important aspects. The bottom line is that we think this legislation is good for our investments in state-regulated gas and electric utilities because it adds numerous mandates that will accelerate investment in their rate base (the investment base that earns the allowed rate of return)  which grows earnings.  We believe that it is also good for the renewable developers (like NextEra and NextEra Partners, which if combined, would be the largest position in our SMA and EMLP portfolios) and service providers that sell to these utilities under long-term contracts.

In our opinion, the legislation also helps our investments in natural gas pipelines because it encourages more renewables that need to be backed up by natural gas fired power generation and because it encourages carbon capture and sequestration.  The legislation calls for a cap-and-trade type of mechanism for carbon emissions for the power sector.  Such a program is technology agnostic and allows the cheapest forms of clean energy to win market share.  We have written extensively on why the last 20-40% of power generation will not be provided by renewables plus batteries because the cost is 10-15 times as expensive as current wholesale market prices for electricity.  There are natural gas technologies already being piloted that – along with carbon capture and sequestration – will be extremely competitive.

The legislation would also modify federal regulation of the construction of new natural gas pipelines that might slow investment, but we see that as positive as the industry has been suffering from too much building.  Besides, in our view, the roadblocks to new construction created by the states and environmental advocates are already more of a constraint than these proposed regulatory changes at the federal level.

The bill also proposes more extensive use of purchase power agreements (PPAs).  These are long term contracts that are used by renewable developers to sell power to the utilities.  Most of these contracts are 20-25 years, making them good investments for us because we like stable earnings.  In the future these long term PPAs might be used for batteries, fuel cells or other smaller more distributed sources of power.  Such an outcome would expand our investment universe further with more opportunities for growth.

For our natural gas utilities there will be incentives to accelerate the upgrade and replacement of older pipes for purposes of both safety and mitigation of methane leaks.  Methane is a 30-80x more potent greenhouse gas than carbon dioxide (depending on the time horizon as its impact dissipates over time) and investment here by the utilities is another opportunity to grow their rate base.

For Investors (not EIP) in the Upstream sector

While the political rhetoric around killing the fossil fuel industry still seems to be articulated by those on the left that always vote for Democrats, this bill and the Biden Energy Plan (discussed in the Section below) takes a decidedly different tone while specifically addressing a smooth transition for incumbent industries and their workers.

Nonetheless, it is hard to find anything good for the oil producers in this bill.  Electric vehicles will be subsidized as will a massive build out of charging stations (also good for our electric utilities).  Capturing carbon from a vehicle tailpipe is uneconomic and so the internal combustion engine will likely give way to battery power which already performs better, and which someday soon will be also be cheaper and more reliable as battery range approaches that of a full gasoline tank and recharging times approach 15 minutes[1]. That someday is when gasoline demand will stop growing and even start to fall and the oil industry will start to shrink, but investors in the oil sector have already suffered far more from decades of capital mismanagement albeit compounded by COVID.

Phillip Morris/Altria is a lesson to those who think a shrinking top line makes for a bad investment as it has outperformed the S&P 500 by about 6% per year over the last 40 years[2] while US cigarette consumption has fallen about 60%.[3] The oil industry loves to blame everyone else for its poor financial performance but sole responsibility lies with senior management who paid themselves to grow production rather than per-share earnings; in our view, most of them need to be pushed into early retirement.

Just to be clear, we seek to avoid investments in the upstream (oil and gas exploration and production) part of the business.

Other industries

As you can tell from the other sections of the legislation listed above, the bill shares the political objectives of the Green New Deal in garnering wider support for comprehensive legislation that has something for everyone including the farmers, Native Americans, inner cities, domestic jobs, etc.  This is how legislation gets the support of those needed to pass it. Joe Manchin, the Democratic Senator for West Virginia, will not vote for a bill that specifically targets shutting down coal plants.  Both of New Mexico’s U.S. Senators are Democrats, but oil and gas and mining support a lot of jobs in the state and remain the dominant source of the state’s gross domestic product and a major source of tax revenue.   All it takes is a few senators from each party with keen constituent interest in one industry to kill  national legislation that could inflict local harm.

The Biden Plan

Biden’s energy plan is on his website and has the following five parts:

  1. ENSURE THE U.S. ACHIEVES A 100% CLEAN ENERGY ECONOMY AND NET-ZERO EMISSIONS NO LATER THAN 2050
  2. BUILD A STRONGER MORE, RESILIENT NATION
  • RALLY THE REST OF THE WORLD TO ADDRESS THE GRAVE CLIMATE THREAT
  1. STAND UP TO THE ABUSE OF POWER BY POLLUTERS WHO DISPROPORTIONATELY HARM COMMUNITIES OF COLOR AND LOW-INCOME COMMUNITIES
  2. FULFILL OUR OBLIGATION TO WORKERS AND COMMUNITIES WHO POWERED OUR INDUSTRIAL REVOLUTION AND DECADES OF ECONOMIC GROWTH

 

You can see the same pattern here where the plan touches on other political issues like national security, infrastructure, income inequality, conventional air and water pollution, economic growth and jobs, etc.

But it also emphasizes things that are good for our portfolio companies like carbon capture and sequestration (highly symbiotic with natural gas), investing in a more resilient power grid, developing hydrogen as a gaseous fuel (which will need to be transported via pipeline not trucks or rail) and investing in a bold energy R&D plan.

I believe this last item (also supported by the Clean Future Act) is one of the long-term benefits few are talking about.  Many years from now we will be enjoying the fruits of inventions that would not have happened without this clean energy initiative. Some will lower the cost of energy or make it more reliable and that is good for our utilities as they spend capital to incorporate these new technologies into an ever more complex power grid. But there will also be inventions that won’t specifically relate to energy just like all the technology that came out of the Apollo space program.

I finish with a quote from Biden’s website on carbon capture:

Biden shares the Carbon Capture Coalition’s goal “to make CCUS[1] a widely available, cost-effective, and rapidly scalable solution to reduce carbon emissions to meet mid-century climate goals.” Toward this end, he will double down on federal investments and enhance tax incentives for CCUS. At the same time, to bring new carbon capture technologies to market, Biden will continue to fund carbon capture research, development, and demonstration.

 

Policies are almost always more moderate than politics.

[1] CCUS – Carbon Capture Use or Sequestration

[1] The Porsche Taycan can charge to 80% of capacity in 15 minutes using a high-power DC charger – source: Chargepoint. Electric vehicle companies continue to develop battery swap technology.  See for example: https://www.nio.com/nio-power.

[2] From October 1980 through October 2020, source: Bloomberg

[3] Source: Statistica; https://www.statista.com/statistics/261573/total-cigarette-consumption-in-the-us-since-1900/ and Bloomberg

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