One Guy's Investments

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Friday, September 08, 2006 -- Subscribe free

Making Money from a Cleaner California?

Probably everyone saw or heard the news about California passing new emissions rules a week ago -- there was an interesting editorial on it in the Salt Lake Tribune recently, and the Washington Post ran a more detailed article when the bill passed. The Financial Times ran a story on the political debate, and the possible business impact on our most populous state.

So what does this mean for investors? Is there money to be made on the tails of this initiative to clean up California's air over the next 20 years and push toward reaching the standards of the Kyoto Protocol?

California already gets most of its energy from relatively clean sources (if you ignore transportation), compared to many states. You can see from this CA Energy Dept. summary how the citizens of the left coast get their energy -- coal is pretty low, renewable sources fairly high.

But they're committing to reducing emissions over the next 20 years even as their population may be expected to grow significantly ... so what companies might benefit from that?

I think there are a few categories that might be worth looking at:

1. Natural Gas. The biggest impact on the electricity market in California is that the state will essentially no longer accept power from the current coal-generated plants. This accounts for about 20% of in-state generation and an unspecificied but probably significant part of their imported electricity (as the Utah story referenced above would indicate, the plants that rely on cheap Rocky Mountain coal and sell electricity interstate will be cut out of the CA market).

To me, that means natural gas will be in higher demand in California because it is the only efficient, relatively clean power source that's likely to be able to take up much of the slack as coal plants go offline. Who benefits? You've got the big natural gas producers like Chesapeake (CHK) or XTO (XTO), the drillers like Nabors (NBR), which has some gas exposure, or Grey Wolf (GW), which is focused entirely on gas.

You might also look to the pipeline companies, since most of California's natural gas is going to have to come in via pipeline from the key producing areas in the Southwest and the Gulf. Here's a map of the pipelines that currently serve the state, you can see that they've got excellent distribution from the big basins already ... but volume should grow, which is how pipelines make money. I'd guess El Paso's (EP) western pipelines are probably among the biggest beneficiaries, but I haven't looked at it in detail.

2. Coal Scrubbers. Alternatively, instead of boosting natural gas usage for electricity generation, you might see an aggressive push for cleaning up coal plants. That says to me that the engineering and construction companies that build and retrofit power plants, and the manufacturers of emissions scrubbers for coal plants, might get some additional business. That could be a lot of folks, but URS (URS) is probably more focused on coal scrubbers than the other big E&C guys, though most of the coal scrubbing I've heard of is focused on removing sulfur dioxide, not carbon dioxide which is the bigger issue here.

It might even be possible to see some of the coal technology companies climb, too, if coal gasification or newer clean coal technologies might get a boost from this renewed focus on emissions -- that could perhaps be folks like Sasol (SSL) with their coal liquefication system, or Headwaters (HW) with their various coal technologies, for example, though I can't claim to know much about that business.

3. Power plants that already run on natural gas. This could conceivably allow for some significant rate hikes in California, if the demand for energy continues to grow but the suppliers shrink. That tells me that the folks who are already online with environmentally friendly or natural gas-powered power sources will have a competitive advantage (as much as the market remains competitive, at least).

PG&E is the big provider here, but I'm not so interested in getting involved with a huge company like that with a checkered history and significant regulatory risk. I've looked a bit lately at a tiny company that might benefit down the road, MMC Energy (MMCN.OB) is a small OTC stock that recently went public (and is moving soon to the ASE to attract more institutional buyers). MMCN is building a holding company for the small power plants that have been divested by larger (and sometimes bankrupt) utilities in high-growth areas ... and they're planning to refurbish and expand those plants with new natural gas turbines to serve peak overload periods at peak rates.

They came to my attention because they recently bought two natural gas power plants in San Diego (Chula Vista and Escondido) that were offline (they're also buying a decommissioned plant in Bakersfield, and have a letter of intent to buy a Utah plant that's under construction) [September 13 update: MMC Energy yesterday terminated their letter of intent to buy the Utah plant], and got them online for summer peak season, with plans to expand at least one of them. This is certainly a risky company, and it's largely unknown so far (though it has been touted heavily by Energy and Capital, a service I know nothing about ... which makes me nervous). I've read the company's filings (if you're interested, please read at least the 10-QSB) and didn't see any red flags, but it's going to continue raising lots more money to buy and upgrade or restore plants so I'd say there's a good chance of significant dilution in the near term.

4. Renewable Energy Companies. This is the sector that immediately comes to mind for most folks when we talk about reducing emissions, though CA will be hard pressed to replace their coal-fired electricity with solar or wind power within the next 20 years. They are, however, trying very hard to subsidize the growth of renewable energy ... as are other states to lesser degrees, and as are several other countries (notably China and Germany).

This is good news for lots of companies, but there aren't many profitable, reasonably priced renewable energy companies ... even though prices are much more reasonable now than they were last winter in the peak of our oil and natural gas panic.

The wind energy bets are few and far between -- you could throw your money at GE, which makes most of the turbines, but wind energy isn't going to move their needle. Or you could look to the composite-materials companies like Hexcel (HXL) or Zoltek (ZOLT) that make or engineer the materials required for efficient windmills.

Solar energy is a much more wide-open business, and with state and local governments also pushing for more rooftop solar cells in new housing production and subsidizing solar implementation elsewhere, demand for photovoltaics should continue apace, with or without California's new emissions rules. You can look at MEMC Electronic Materials (WFR), which I own, as the supplier of the silicon wafers that go into solar panels, or you can look at the manufacturers like Suntech Power (STP -- my favorite among these with their Chinese connection), Evergreen Solar (ESLR) or SunPower (SPWR -- or look at CY to possibly buy control of SPWR on the cheap).

Will California's plan really fly, or will this plan move to other states? It's way too soon to tell, but the California auto emissions rules certainly had a massive impact on the rest of the country and on auto manufactureres worldwide, and as one of the largest economies in the world you have to accept that state decisions really matter (CA is somewhere between the fifth and 10th largest economy in the world, right up there with Italy and France if treated as an independent nation -- just how big depends on who you ask).

I don't know whether they can pull off an emissions trading scheme with just one state, but it's certainly possible -- and they can definitely cut off all "dirty" power supplies, which will impact the energy business writ large across the Western US in a big way ... whether any of these companies, or others, will actually benefit is certainly an open question, these are just the initial ideas that came to my mind.

In the interest of full disclosure, at the moment I own shares in WFR, preferred (series D) shares in CHK, and call options on CY, and I've been toying with the idea of buying MMCN and may do so soon.

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Travis, that's a good wriiteup; thanks. MMCN is now on my radar. If they are 'solid' (by that I mean, at this stage, a solid management/financial team that really does seem to know what they are doing and will stick it out). They almost sound like AES did in its early, optimistic, halcyon days.

I'm curious as to what criteria you're using for yourself for deciding (if you do decide to buy) on what price to pull the trigger on.
Thanks Dave. I'm impressed by their board -- they've got some board members from utilities and some industry veterans, but the management team are largely wall street folks as far as I can tell.

I don't have any fair way of valuing the company, which is part of the reason I haven't yet picked up any shares -- with so much growth planned and so little in the way of cash flow on the books so far, it's hard to pick a real number. If I do decide that I'm confident in management and in their business plan I'll probably just average in over a period of time to avoid picking a price at random (if you're a technician, you may be able to tell something from the charts -- but I'd be hard pressed to rely on that since they just barely have a 50 day chart at this point.

Cheers, and thanks for reading and commenting.
For solar you should check out Renewable Energy Corporation.

Thanks Mr. E., always happy to hear about another company to look at.
If I do decide that I'm confident in management and in their business plan I'll probably just average in over a period of time to avoid picking a price at random (if you're a technician, you may be able to tell something from the charts -- but I'd be hard pressed to rely on that since they just barely have a 50 day chart at this point. buy thesis
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