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What Investors Need to Know About the Energy Bill

by | published July 16th, 2010

The latest version of a scaled-down energy bill is barely out of a Senate committee… and already the pundits are saying it will not pass. With members of Congress looking to start re-election campaigns shortly after Labor Day, the calendar gives the Obama administration little time to push through a bill of any kind.

Even in the aftermath of the spill in the Gulf of Mexico, this is not the time to tinker with the entire energy sector. And it appears the White House has recognized this fact.

Unlike previous proposals, whatever emerges will be a much less controversial approach. Nonetheless, it is still certain to prompt most Republicans to vote against it and even introduces the prospect of liberal opposition. It remains too radical a move for the first camp; too much of a sellout for the second.

Make no mistake, however: This bill, even in its watered down state, will change how investors need to view the energy sector. As such, we will be watching its movement for early indications of favored plays.

The Democratic leadership would still like to include a carbon emissions tax in the draft that’s currently making its way through the Senate. The version passed by the House last year had one, and I still believe we will end up with a carbon levy in the not-too-distant future. There are also Environmental Protection Agency (EPA) standards existing that emphasize a reduction in overall carbon emissions. The Senate defeat of an attempt to limit the EPA in this area (“Two Ways to Profit from the Coming Carbon Cap“), guarantees that the issue will remain a policy issue even without the new energy legislation.

But the political objective at this point is to pass something before the mid-term elections. And that almost certainly obliges a contentious issue like the carbon cap to end up on the cutting room floor.

Still, there will be some interesting aspects for the investor to consider. Four of these I see as the most important…

1. A Commitment to Alternative Energy

The bill still includes significant commitment to alternative energy in the form of tax credits and some subsidies. Most approaches here, especially renewables, are not yet at the point where more than a few fledgling companies will become breakout successes. Additional developments must occur in virtually all segments from production technology (read R&D here) to infrastructure. These are very expensive for processes that may be considered the wave of the future for many yet lack a ready market or an accessible and available delivery system today.

We will see some boutique successes, forerunners of more pervasive approaches to come. Yet, without significant tax and investment assistance, only a very slow broad-based expansion will be hallmarking alternative energy as a whole.

The move by the average investor here is to play the entire sector through the use of exchange traded funds (ETFs). These can either emphasize non-fossil fuels or green technology by using the Powershares Cleantech (NYSE:PZD) ETF. Or, for a more international application, the Market Vectors Global Alternative Energy (NYSE:GEX) ETF. Individual companies will still have capitalization problems and thin trading for the most part until the sector starts moving. That is likely to be several years from now, but the move will be dynamic.

2. Increasing Renewable Energy Standards

The new legislation will contain renewable energy standards, providing an increasing reliance on biofuels over the current 36 billion gallons by 2022 (“Washington Just Made Biofuels a Priority“). Unfortunately, these will look more like political sops than genuine advances.

Heading the list here will once again be subsidies for expanded ethanol production, despite some rather clear indications that the train has already left the station. Ethanol and other cellulose-based fuels will certainly be a factor in the evolving energy mix, but hardly a major leader. I continue to advise using the Elements MLC Biofuels Index Total Return ETN (NYSE:FUE) as the best entry into the biofuels market. A Congressional mandate that retail gasoline sold in the U.S. contain a greater ethanol component will enhance return on selected biofuel shares. However, this is not the source of the primary alternative fuel breakthrough we await.

3. How We Fuel Our Vehicles

There will be a major departure in how we favor fueling vehicles. There are two important changes coming here…

Almost without question, the bill will include incentives for electric vehicles. The debate over the death of the electric car is over. This phoenix has arisen from the ashes. Analysts expect 500,000 to be on the road over the next several years. Even without advances in battery technology, these cars will go about 100 miles a charge. With over 72% of Americans driving less than 50 miles a day, and most urban areas ready to embrace them, the market is here.

Additionally, in what I regard as the most significant likely change in the new legislation, the administration seems ready to ally with natural gas interests in emphasizing a transition from gasoline to compressed natural gas (CNG) as fuel for private and commercial transport. What will be needed is subsidies for service station overhauls (I estimate about $84,000 per station for at least one CNG pump) and transition to the production of both conventional autos and hybrids running on CNG. This will likewise make significant use of the new sources of unconventional natural gas (shale, coal bed methane, tight gas) the U.S. now has in abundance – a welcome additional advantage in offsetting reliance on foreign sources of crude oil for gasoline and diesel production.

These two fuel revisions, along with the infrastructure, support and service elements that will come with them, are the most interesting new development in the energy sector.

4. Oil Drilling Regulations

Finally, there will be a stiffening of oil drilling regulations. While this is hardly news, given the drama that has been unfolding off of Louisiana, it may not simply be confined to deepwater drilling. All offshore drilling, regardless of the water depth, will fall under greater government scrutiny. The Bureau of Ocean Energy Management, Regulation and Enforcement (the new name for the discredited MMS) will require that operators obtain more formal approvals at more junctures in the drilling process. That will add lead-time and increase up-front expenses, but is probably an inevitable result of the Macondo well blowout.

There is some movement to increase oversight for onshore drilling as well. I do not see this as resulting in much short-term change, since there are already enforceable regulations on the books. Greater diligence in their application, on the other hand, seems a given.

As the legislation reaches its final form, the investment opportunities will also become clearer. Expect to see retail and institutional investors revise their strategies in anticipation. Our approach in this sector will be flexible, too. Even in the event that the bill does not pass this year, something akin to it will pass next year… regardless of which party wins in November.

Kent

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