Tighter CO2 Emission Norms Could Mean Thinner Margins For Duke Energy Ahead

The Natural Resources Defence Council (NRDC), an influential national environmental group, has outlined a proposal to the Obama Administration to enable the United States to cut down on greenhouse gas emissions from power plants by about 26% by 2020. ^[1] The NRDC’s plan proposes an extension to the Clean Air Act to reduce carbon dioxide (CO2) emissions from existing power plants and outlines the use of different initial emission norms for states based on their current power generation mix.

More stringent emission norms will impact utility firms like Duke Energy (NYSE: DUK), which are dependent on fossil fuels like coal and natural gas for most of their power generation, requiring them to invest in cleaner generation techniques or pollution control equipment.

CO2 Emission Cuts for Existing Power Plants Are Inevitable

We believe that it is only be a matter of time before the government steps up its CO2 regulations for existing power plants, irrespective of whether it buys into the specifications of NRDC’s road map or not.  

While the US Environmental Protection Agency (EPA) currently has legislation in place to reduce carbon pollution for the transportation sector and newly built power plants, it has yet to take solid steps to restrict CO2 emissions from existing power plants, which are currently subject to limits on mercury and other toxins under the Mercury and Air Toxic Standards (MATS). Power plants alone are responsible for about 2.4 billion tonnes (40% of total US emissions) of annual CO2 emissions, which would make them an important area to tackle, if overall CO2 emissions are to be brought down.

President Obama has had a decidedly pro-environment stance calling for a reduction in green house gas emissions in the past. He also has a track record of being tough on fossil fuels. Since stricter CO2 norms could possibly be implemented as an extension of the Clean Air Act, it would not need approval from the Congress, giving the President a freer hand to speed up the process.

How Could Duke Energy Be Impacted?

Duke Energy, which is one of the nation’s largest utility companies, with a capacity of 58,200 MW, is likely to be impacted significantly if more stringent CO2 regulations for existing power plants are to come into effect. While the firm has been investing in transitioning some of its generation to cleaner fuels like natural gas and nuclear energy, coal fired plants still account for almost 40% of the firm’s power generation mix. ^[2] Additionally, some of these plants are several decades old making them relatively large emitters of CO2.

Recently, Duke retrofitted about two-thirds of its coal powered plants with selective catalytic reductions technology (SCR) and scrubbers to comply with MATS Act. And now, potentially reducing CO2 emissions would call for installation of expensive equipment like carbon capture and sequestration, which could drive up the firm’s capex as well as the generation costs. This could potentially impact the firm’s margins in the short term.

We have a price estimate of $68.35 for Duke Energy, which is about 10% ahead of the current market price.

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1. U.S. Could Cut Power Plant Pollution 26%, NRDC Says, Bloomberg Businessweek [↩]
2. Duke Energy Q3 Earnings Presentation [↩]