Investments For An Obama Administration

Dec 15 2008 | 2:00am ET

By David Kurzman -- We have been inundated with questions from investors wanting to know how to position their portfolios to benefit from an Obama Presidency. The talking heads on CNBC, Fox Business, and MSNBC are throwing around words like “infrastructure” and “renewables” with little real discussion about how exposed or unexposed individual companies may be to the likely trends.

Investing in Regulatory-Driven Businesses

During economic downturns, such as the severe recession we are experiencing, corporate and consumer spending declines are the norm. But businesses that are driven by regulatory requirements, such as pollution control, safety equipment, and mandated purchases of renewable power, are likely to experience a muted downturn or even significant growth.

Following eight years of a relatively toothless Environmental Protection Agency (EPA), we expect renewed vigor in environmental legislation as the incoming director will likely be given nearly carte blanche to review the existing regulations. In particular, we hope to finally get resolution related to the Clean Air Interstate Rule (CAIR), which was thrown out by the appellate court late in our current president’s second term.

CAIR was originally issued by the EPA in March 2005, and it was designed to achieve the nation’s largest reduction in air pollution in more than 10 years by regulating the permissible pollution emissions allowed to cross state lines. The key to CAIR was that it would, “…provide health and environmental benefits valued at more than 25 times the cost of compliance” by creating permanent caps on the allowable emissions of sulfur dioxide (SO2) and nitrogen oxides (NOx) in the Eastern U.S. These gases are chief contributors to the production of acid rain and smog, respectively.

The Clean Air Mercury Rule (CAMR), which is closely related to CAIR, was the U.S.’s first federally mandated requirement for coal-fired electric utilities to reduce their emissions of mercury (which is released from coal when burned). But in July of 2008, a three-judge panel on the U.S. Court of Appeals for the District of Columbia Circuit ruled unanimously that the EPA overstepped its authority by instituting rules that would have established a cap-and-trade system for soot and smog. These are major components of the underlying rules. To add insult to injury, the court ruling came on the same day that the administration said it would take no steps under the Clean Air Act to regulate greenhouse-gas emissions that contribute to warming, even though the EPA formally announced that it would ask for public comment on the matter.

With the Supreme Court’s recent ruling that the EPA must regulate carbon dioxide emissions as a pollutant, we expect resolution for CAIR and CAMR soon. The Obama administration will very likely address the “fatal flaws” mentioned by the U.S. Court of Appeals and develop either by executive order or regulatory promulgation a stronger rule. In fact, a national cap and trade regime for carbon dioxide emissions (which was not covered by CAIR or CAMR) will set a precedent for revisions to CAIR and CAMR. That was a long way of saying that pollution abatement companies are positioned to benefit. Specifically, producers and suppliers of activated carbon, which is an inexpensive and market-tested way to reduce mercury and similar pollutants from coal-fired power plant emissions, are likely to benefit. There are few domestic suppliers of activated carbon (AC), and China, which until recently was a net exporter of AC (subject to a US importation tariff), has recently become a net importer of AC due that nation’s growth in new coal-fired power plants. Besides Calgon Carbon (CCC), the most promising micro-cap company we have reviewed is tiny and illiquid ADA-ES (ADES).

ADA-ES manufacturers and installs AC injection systems (the razor) and currently buys AC (the razor blade) for pollution abatement. This small-fry company has garnered nearly half of the market sales of AC injection systems, and has already broken ground on a new AC production facility at the mouth of a lignite mine in Louisiana. Interestingly, initial financing for this facility has been provided by former Goldman Sachs bankers that left to start their own fund.

We have met with ADA-ES’s management a few times and always came away feeling confident that they were the right management to execute a project of this magnitude. This is why we continue to hold a small position of ADA-ES in the KCR© Strategic Portfolio. We would like to increase the position materially, but the lack of liquidity in ADES shares and our own mandate that no position represent more than one trading day’s volume, limits our exposure at this time. We will revisit Calgon Carbon in the months to follow as there may be an opportunity there.

Renewable Portfolio Standards

There is another kind of regulatory-driven business that will likely grow and encompass the entire U.S. economy under an Obama Administration. Specifically, we are referring to the growing likelihood that a national Renewable Portfolio Standard (RPS) will be established.

Currently, about 27 states and the District of Columbia have each passed their own RPS, which mandates a specific level of electricity must be generated by renewable power sources in those states by a set date or dates. But no two state’s standards are the same. For instance, New York requires Investor-Owned Utilities to generate or acquire 25% of its delivered electricity from renewable sources by 2013. Renewable power sources, according to the New York standard, include: Photovoltaics, Landfill Gas, Wind, Biomass, Hydroelectric, Fuel Cells, Anaerobic Digestion, Tidal Energy, Wave Energy, Ocean Thermal, Ethanol, Methanol, and Biodiesel. Also, approximately 19.3% of the target will be derived from existing renewable energy facilities (namely existing hydropower from the likes of Niagara Falls!) and 1% of the target is expected to be met through voluntary green power sales. So New York State has allowed itself to start with about “19.3% achieved,” with another 5.7% to go.

By comparison, California’s RPS requires Investor-Owned Utility, Electric Service Providers, Small and Multi-Jurisdictional Utilities and Community Choice Aggregators to generate or acquire 33% of their electricity from renewable sources by 2020. According to the state of California, qualifying technologies include: Solar Thermal Electric, Photovoltaics, Landfill Gas, Wind, Biomass, Geothermal Electric, Municipal Solid Waste, Anaerobic Digestion, Small Hydroelectric, Tidal Energy, Wave Energy, Ocean Thermal, Biodiesel, Fuel Cells using Renewable Fuels.

A national mandate, set in a Goldilocks fashion (“not to high, not too low, just right”) will encompass all states (most southern states burn tons of coal, and they do not have RPS’s), and create a common standard
by which all must adhere.

We expect a national RPS to drive the already-strong solar, wind, geothermal, and other renewable businesses to new heights. We have selected two of the best positioned solar manufacturers, SunPower (SPWR) and First Solar (FSLR), and geothermal power producer Ormat (ORA) for inclusion in our portfolio.

David Kurzman is Managing Partner of Kurzman CleanTech Research and Kurzman Capital. Prior to launching his consulting firm, he served as Managing Partner of Kurzman CleanTech, a five-year-old hedge fund investing in clean technology companies and led the CleanTech Research Group for Panel Intelligence, a primary research firm.

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