Under Trump, Utilities Find Themselves Between a Rock and a Hard Place

By Travis Hoium Markets Fool.com

These are supposed to be bright days for the utilities and power producers that own coal and other fossil fuel power plants across the country. Republicans control Congress, the White House, most state governorships, most state legislatures, and soon (likely) the Supreme Court. And a central theme of their pitch to voters and business leaders has been that they will reduce the regulations that are choking American business, namely by killing the Clean Power Plan and bringing back coal, expanding fracking, and making American power generators great again.

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But in the first two months of the Trump Administration, there have been more coalplant closures announced, and utilities don't seem to be eager to expand their fossil fuel asset base, particularly coal plants. There are a lot of reasons that energy is getting cleaner, not dirtier, putting utilities in a tough spot between politicians who want more fossil fuels and the realities facing their businesses.

Image source: Getty Images.

Politicians come and politicians go

I want to make one thing clear early on: Investing based on politics isn't a good idea. But that doesn't mean politics doesn't affect investing. And 2017's energy industry is a great example of that.

Coal was supposed to be the big winner of 2017, but since the election, AES Corporation (NYSE: AES) has announced a coal plant closure, and a massive plant owned by Pinnacle West's (NYSE: PNW) Arizona Public Service and Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) subsidiary NV Energy has announced its closure, planned for 2019. This is on top of hundreds of coal plants closed or planned to be decommissioned in the last decade. Utilities are finding that coal plants just aren't a good investment, and it isn't because of current trends in regulations. It has more to do with where regulations may be a decade from now and with the low cost of renewable energy, which has much less regulatory risk.

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While it might seem like the political environment would be ripe for at least keeping coal plants running, that's not how the utility business works. Utilities have to think about how regulation and politics might affect their business a decade from now. Climatewire reporter Emily Holden recently highlighted why the elimination of the Clean Power Plan (CPP) now might actually be bad for utilities from a regulatory perspective if the political power flips in four or eight years (as it did from 2008 to 2016).

ICYMI, this is how some Republicans in the energy world are feeling about Trump. $https://t.co/KhyolvNXtQ pic.twitter.com/KF46i97v8x

-- Emily Holden (@emilyhholden) February 16, 2017

The fact that it's possible that regulations could be even stricter in the future if political winds shift is a big deal for the utility business.

Maybe the Clean Power Plan is a good thing for utilities?

One of the best arguments utilities themselves made for the CPP is that it set the rules of regulation and compliance years in advance. When the CPP's legal standing was in question, they didn't know the rules of engagement. Under the CPP, everyone knew there was going to be a push away from coal and toward cleaner sources of energy like wind and solar, so they could prepare for it.

Under Trump, it's clear that the political winds have moved in the opposite direction, which was predictable. But that doesn't mean the current deconstruction of regulations will last. If the political power shifts in four or eight years, the return of stricter regulations that harm the economics of fossil fuel plants could be back. And they could be worse than under the CPP.

This presents a challenge for companies like Calpine Corporation (NYSE: CPN), Dynegy Inc. (NYSE: DYN), Exelon Corporation (NYSE: EXC), and NRG Energy Inc. (NYSE: NRG), which are independent power producers that sell energy to utilities. They operate largely in the unregulated energy market, generating a return on power plant investments over 30-plus years. If they build a coal plant today that makes sense under today's rules and suddenly regulations change down the line, that investment could be a money-loser. And each of these four companies has struggled over the last decade with the transition away from coal to both natural gas and renewable energy. So they don't have much appetite for risk in testing the regulatory future.

In the short term, the elimination of a regulatory framework like the CPP may be a positive for utilities, but if the CPP is replaced by more burdensome regulations in the future, it could be even more damaging. And that's a reality they have to contend with in their decision-making process. Do you choose the short-term profit and risk long-term value destruction, or take the short-term hit and shut down dirtier fossil fuel plants in an effort to find a way to invest in energy sources that are cleaner? That's the rock and the hard place executives find themselves between.

Long term, low-carbon options are winning

Regulations are always a challenge in the energy business, but in the long term the trend is away from pollutive sources of energy like coal and toward cleaner forms of energy like natural gas and renewable energy. Given the economic momentum behind wind and solar, I don't see that changing anytime soon. And with the energy industry looking to invest on a multidecade cycle that will span multiple presidential and congressional terms, corporations and executives would be wise to follow the long-term trends and not be distracted by the short-term political rhetoric -- because the winds of Washington, DC, could change in just a few years.

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The author(s) may have a position in any stocks mentioned.

Travis Hoium has no position in any stocks mentioned. The Motley Fool owns shares of NRG Energy. The Motley Fool has a disclosure policy.