Insights: Investing
In early June, the Bush Administration unveiled its long-awaited national energy plan. Predictably, the plan was greeted with outrage by environmentalists, scorn by Democrats and confusion by the public. Leaving politics aside, we have long advocated some form of economically sensible national energy policy. We asked Tim O'Brien, portfolio manager of the Gabelli Utilities Fund, to critique the Bush plan and the Democrats' counter proposals, and offer some suggestions as to how investors might profit.
--Mario Gabelli
President Bush's recently announced energy policy made me so angry I left my air-conditioned office in a three-story glass building, jumped into my 12-mile-to-the-gallon SUV, drove to my 4,500-square-foot-air-conditioned home, booted up my PC and sent e-mails to my congressman and senators demanding that we focus on energy conservation rather than increased energy supply. After expressing my outrage at the Bush plan, I grabbed a bottle of Chardonnay from my elevator-sized refrigerator and fired up the hot tub for a long soak. This is the response of typical Americans to the Bush energy plan. They talk the talk when it comes to energy conservation, but don't walk the walk, and the inconsistency bothers them not at all.
As the top chart, U.S. Energy Consumption by Category, reveals, America's energy consumption has expanded dramatically and is expected to continue rising through 2020. The percentage of energy consumed by residential customers has held relatively steady at about 20 percent of the total. On a percentage basis, commercial use has risen while industrial use has declined, reflecting the transition from a manufacturing- to a service-oriented economy. The percentage of energy consumed by transportation has trended higher, a reflection of the failure of mass transit in car-loving (or now perhaps more accurately, SUV-loving) America.
The bottom chart, U.S. Energy Consumption by Source, reveals that the use of oil has remained around 40 percent of the total and that renewable energy has held steady at around 7 percent. The use of coal has declined substantially and the use of nuclear power has been halved -- both reflections of environmental concerns. The big jump has been in natural gas, now the preferred feedstock for generating electricity.
Ever increasing demand for electricity is a big part of the growth in energy consumption. Since 1978, the number of homes in the United States with seven or more rooms has risen from 22 percent to 29 percent of the total. The percentage of U.S. homes with air-conditioning has risen from 56 percent to 73 percent. With the fastest U.S. population growth in the South and West, this trend is not going to change. Our appliances have gotten more energy-efficient, but we are now buying bigger ones and more of them. In 1978, space heating accounted for 66 percent of U.S. residential energy consumption while appliances accounted for 23 percent. By 1997, space heating had fallen to 51 percent of residential energy consumption while appliances (bigger refrigerators and the proliferation of PCs) had grown to 27 percent. The average PC consumes around $100 per year of electricity. The commercial use of PCs also has soared -- another reflection of rapidly increasing commercial energy consumption.
Every year the United States produces less energy and imports more than it did the year before. No amount of conservation will change that. No amount of new resource development will change that, either. However, a balanced mix of conservation initiatives and new resource development can have a meaningful impact and is certainly better than doing nothing.
Judging from the public's response to the Bush energy plan, the concept of energy conservation is wildly popular, while developing new energy supplies and beefing up our energy infrastructure is very low on the average American's priority list. Incentives for increased exploration and production are perceived as a political favor for ìBig Oilî and another blow to environmentalism. Despite the obvious need for more electric generating capacity and more efficient systems for distributing power, state and local politicians won't play ball. California has become a B.A.N.A.N.A. Republic -- Build Almost Nothing (particularly not an electric generating plant or more transmission lines) Anywhere Near Anyone -- and, in the middle of the second year of rolling blackouts, the average Californian still does not believe that there is a real problem. Instead of dealing with the real issues, California Gov. Gray Davis has spent the past year peddling increasingly bizarre conspiracy theories while his state's largest utilities¼bled cash and entered or approached bankruptcy. If we could harness the energy content of all the hot air being expended by the politicians on the energy crisis, we wouldn't have one.
The Bush energy plan is a good, albeit not perfect, plan, and a better plan than has been portrayed in the media. It focuses on new technologies to increase energy supplies (low impact drilling, clean coal and pebble-bed nuclear\; increased emphasis on expanding and upgrading energy infrastructure (incentives and fast-track approvals for natural gas and electricity transmission networks); and incentives and mandates for conservation (tax credits for hybrid and fuel-cell vehicles, and requiring higher fuel economy for cars and SUVs).
Unfortunately, the presentation of the plan to the American people was clumsy beyond belief, and this made it easy for the Democrats and the media to slam the plan as all supply, no conservation. With the Democrats now controlling the U.S. Senate, the administration will have to compromise more than it would like. This is likely to lead to an energy policy that, on balance, is better than the original Bush proposals. Whatever happens will probably happen quickly for two reasons. First, people are upset about high energy prices and supply disruptions, and the politicians must be seen to be responsive to public concerns. Obstructionists will be punished at the polls. Second, energy prices will eventually fall of their own accord as producers increase production to cash in on the high prices and energy users reduce consumption to save money or because they have been thrown out of work. So, the politicians must act quickly enough to be able to claim credit.
If there is a flaw in the time-tested free market approach being offered, it is that it will have next to no impact on the current crisis of high prices and supply disruptions. Citizens sweltering in the dark in San Francisco or paying $2.75 per gallon to fill up in Chicago are not likely to be impressed with the Bush plan.
The Democrats are pushing a package of counter proposals that are politically palatable but economically insane. The pillars of the Democratic package are price controls, conservation and incentives for renewable energy production. Price controls would reduce incentives for producers to produce and for consumers to conserve. Controls would take the current problem and turn it into a disaster. Conservation is vitally important, but not a solution by itself. Much of the gains attributable to conservation have come from things that are relatively easy and cheap: better-insulated homes and commercial buildings, more efficient appliances and better automobile fuel economy. Going forward, conservation would involve sacrifice like turning the air-conditioning off or trading in that SUV for a compact car -- the kind of things Americans traditionally resist.
Renewable energy is helpful, but not the answer. After decades of subsidies, tax credits and mandatory set-asides, renewable energy accounts for just 2 percent of U.S. electricity supply and is projected to reach 3 percent by 2020. We've already exploited all of the hydroelectric resources available and just about all of the geothermal. Solar, wind and biomass technologies continue to improve but also have limited potential. Renewables accounted for 7 percent of U.S. energy consumption in 1999, and the U.S. Department of Energy projects that renewables will account for the same 7 percent of consumption in 2020. About 55 percent of renewables are used for electricity generation while the balance are used in heating and cooling, cogeneration and transportation (ethanol fuel blending, heavily subsidized by federal tax credits). Renewables will become increasingly important, but are only a small part of the solution to our energy needs.
The president should have stressed conservation and renewables much more aggressively in his proposal because they are politically popular (if economically questionable). If Bush would embrace and promote conservation and renewables, his proposals for new supply and an improved energy infrastructure (90 percent of any legitimate long-term solution to the energy crisis) might gain some political momentum.
The implications of the Bush plan, or a compromise version for investors are fairly clear. Owners and developers of clean, modern and efficient gas-fired electricity generating plants are going to see plenty of opportunity for years to come. (All prices as of July 16.) Clear beneficiaries include El Paso Corp. (NYSE-EPG-$51.92) and Calpine (NYSE-CPN-$43.75) among others. Gas turbine and power equipment makers will continue to see growing order books. Among these are General Electric (NYSE- GE -$46.22) and Shaw Group (NYSE-SGR-$37.65). The pure play for automotive fuel cells is Ballard Power (NASDAQ-BLDP-$44.55), although the stock is wildly overpriced relative to near-term prospects given its multibillion-dollar market valuation and next to no revenues. Major beneficiaries of the solar cell tax credit extension include AstroPower (NASDAQ-APWR-$47.91) and Unisource (NYSE- UNS-$22.80). Drillers and drilling equipment and service companies too numerous to mention should see ongoing improvement in their outlook, with volatility along the way. These companies are only a handful of the long list of potential beneficiaries.
We all look forward to the day when fossil fuels are history. But, scientists have been working on things such as nuclear fusion and fuel cells for decades, and although we are seeing progress in these fields, we may be decades or more away from making these technologies economically competitive with coal, oil and natural gas. In the interim, a national energy policy addressing supply, energy distribution and conservation is essential.
Mario J. Gabelli is the founder and chairman of Gabelli Funds Inc.