Copenhagen's Delay Fires Coal

By LIAM DENNING
In Copenhagen, world leaders debated climate change they didn't quite believe in enough to overcome political obstacles. What does their lack of agreement portend for the U.S. electricity sector?
More uncertainty is the short answer. When and how America will handle carbon emissions are variables affecting every power company's investment decisions and valuation.

Selling even a multi-lateral settlement to Americans was going to be difficult in the wake of the "Climategate" revelations throwing doubt on the science of global warming. Unilateral legislation ahead of next year's mid-term elections now looks all but impossible. Meanwhile, the alternative route of having the Environmental Protection Agency regulate carbon emissions as pollutants would likely provoke strong legal challenges.
Rob LaCount, a senior director at IHS Cambridge Energy Research Associates, reckons that as the window of opportunity for passing comprehensive legislation closes, a more piece-meal approach becomes likely.
The big losers from this continued uncertainty are companies with large, unregulated nuclear power portfolios, such as Exelon and Entergy. Nuclear plants, with their zero carbon emissions, represent an option on carbon. If carbon were to become embedded in the electricity price, as coal and natural gas-fired generators factored it into their costs, the benefit would flow to the nuclear generators' bottom lines. The more that day is deferred, the less tangible those extra cash-flows are.
Conversely, unregulated power producers burning coal benefit from this stay of execution. Not all benefit equally, however, with much depending on the regional market in which they operate. In the absence of a cost of carbon, coal-fired generators selling into wholesale markets where natural gas-fired plants set the marginal price of electricity tend to earn good profit margins per megawatt-hour of electricity produced.
Carbon pricing would savage such margins—that's the idea, after all. In its absence, it might be time to reappraise Allegheny Energy, the worst-performing member of the S&P Utilities index this year. As Morgan Stanley points out, its unregulated generation portfolio is mainly coal-fired, operating where gas-fired competitors set electricity prices. At 11 times 2009 earnings versus a sector average of 13.4 times, Allegheny appears priced for change that Copenhagen did not deliver.
Write to Liam Denning at liam.denning@wsj.com