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Using The Emissions Cost Curve To Identify Investment Opportunities

Companies / Corporate Earnings Oct 02, 2007 - 12:38 AM GMT

By: Hans_Wagner

Companies Best Financial Markets Analysis ArticleInvestors who beat the market look for opportunities in places before others arrive on the scene A recent edition of The McKinsey Quarterly discussed “A Cost Curve for greenhouse Gas Reduction” The McKinsey Quarterly September 27, 2007 . The study presents their analysis of the costs to abate greenhouse gases, especially CO 2 . Their goal is to provide a framework for policy makers and business people as they debate future regulation.


In that they did an excellent job. This framework also provides an interesting point of view for investors to might wish to consider companies that will participate in the effort to reduce greenhouse gases. The idea is to go beyond the more obvious focus on alternative energy plays, solar and wind farms. 

Background

This McKinsey study examined each significant method to reduce emissions across geographic regions and business sectors to create related cost curves that show the cost of each approach both globally, by region and by sector. The study spans three time horizons, 2010, 2020 and 2030 and concentrates on abatement measures that they estimate would cost 40 euros per ton or less in 2030.

The study concentrates on the economic price to the global economy of making any approach to abatement cost competitive or otherwise viable through policy decisions. Using their example of wind power, the abatement potential of wind power is their estimate of the feasible volume of emissions that could be eliminates at a cost of 40 euros a ton or less.

Below is a simplified version of the global cost curve showing the cost of feasible abatement measures in 2030. What is interesting from this chart is at the low end of the curve are abatement measures that reduce the demand for energy. The problem here is that many of the emitters are consumers where it is difficult to realize the result of abatement measures without directly increasing their costs. Certainly, this area will offer opportunities for investors.

Higher up on the curve we see what many consider to be the largest causes of greenhouse gases, power generation and manufacturing. These emitters are more easily targeted by policy makers. They also are a big target for many green activists. This area also offers opportunities for investors which we will explore more in this article.

Implications for Policy

An interesting facet of the study is the power generation and manufacturing industries are the primary focus of the climate change problems, yet they account for less than half of the potential for reducing emissions. As already mentioned, these two industries represent a major focus of environmentalists and governments seeking to reduce emissions. As a result there will be a major shift from the traditional coal fired generation plants to coal plants with carbon capture and storage, to renewable energy and to nuclear power. This will require significant future investment dollars to try to reduce CO 2 greenhouse gases. 

An important economic factor that policy makers and business people will likely consider is it is cheaper to build clean or energy-efficient technologies when building a new power plant, house or truck, than to retrofit an old one. This raises an important issue. Implementation of new clean or energy-efficient plants and buildings requires a set of known emission standards that must be met before design and construction can begin. For example, in the United States, many new coal fired electrical generating plants are on hold until policy makers pass a set of emission standards. For those interested in learning more about global economic growth I suggest reading Economic Growth by David Weil. It is an easy to read book that presents the key factors to understand global economies. It is expensive and is used as a text book for college students, but it is worth the money.

Now let's get back to the emissions problem. It is interesting to know that engineers believe they can capture, store or dispose of CO 2 emissions once they know the goal. For example, a ccording to executive management of McDermott, their engineers have stated, “If we just had known that we need to eliminate CO 2 we would have accomplished that, just like we did the harmful particulates we eliminated years ago.”

Investing Implications

There are many companies that are likely to participate in the massive effort to reduce greenhouse emissions. The following list is just come of the better ones that investors should consider.

Jacob's Engineering Group Inc. ( JEC ) - Jacob's Engineering design and develops buildings and plants for companies and governments across the globe. This includes engineering, constructing, operating and maintaining a diverse array of facilities including pharmaceutical plants, oil refineries, chemical plants, hospitals and bridges to name a few. Recent clients include Bidachem S.p.A. for a new active pharmaceutical ingredients facility and Motiva Enterprises LLC facility in Port Arthur, Texas that will add 325,000 barrels per day (BPD) of refining capacity essentially doubling the size of the refinery to more than 600,000 BPD, making it the largest U.S. refinery and one of the largest in the world. 

With the growing interest in energy efficiency for new buildings, Jacobs is in a distinctive position to include energy efficient materials in the buildings that it designs and constructs. Its customers want to save money on the high costs of energy and they also wish to demonstrate they are doing their part to lower emissions. JEC is in a unique position to take advantage of global economic expansion. In fact, the company has operations in North America, the United Kingdom, Europe, India, Australia, and Asia. 

The most recent quarter showed earnings up more than 47% over the prior year and a back log of $11 billion – a 17% increase over the same time last year. Not only did they beat earnings estimates, but also guided higher for the year.

McDermott International ( MDR ) – This is an energy services company that installs offshore drilling rigs, pipelines and sub sea production systems. It also provides nuclear components to the US government and constructs electric power generation systems. In Saskatchewan, Canada they are working on a 300 megawatt facility that will virtually clean the power plant of all CO 2 emissions. This project is just underway and still must be proven. However, if it proves successful it could prove to be a significant boon to the fortunes of MDR and to the reduction of CO 2, a major green house gas.

In another development B&W and American Electrical Power (AEP) plan to pursue the commercial viability of a new combustion technology to reduce CO 2 and other emissions from coal-fired power plants. These firms intend to assess the application of oxy-coal combustion as a retrofit to an existing AEP plant, working toward the development of the first oxy-coal commercial validation project in the United States. According to B&W oxy-coal combustion uses pure oxygen for the combustion of coal in electricity generating plants. The idea is to eliminate the nitrogen that comes in with air during the combustion process. When this is done the exhaust gas is a relatively pure stream of CO 2 that is available for capture and sequestration or used for alternative purposes, such as enhanced oil recovery. This technology is expected to result in near zero emissions from coal fired electric generating plants. American Air Liquide, Inc. is collaborating with B&W in this effort.

Revenues have grown over 35% and earnings jumped up over 200% in the latest quarter. While MDR's stock price has risen as well, they still represent a significant opportunity for investors as the company expands its business and begins to benefit from the transition to green energy in the years to come. 

Foster Wheeler ( FWLT ) - Foster Wheeler designs onshore and offshore oil and gas rigs, natural gas liquefaction facilities oil refineries and other facilities for the petrochemical industry. On the green side, the company provides infrastructure support for power plants and waste processing plants. In 2007 Foster Wheeler continues grow through large contracts for energy companies, though their earnings fell in the latest quarter, due to a very unusual prior year's quarter.

Foster Wheeler has developed methods to burn a wide range of fuels including biomass and municipal solid waste to generate electricity. They also are working to solve the CO2 emissions problem through their Circulating Fluidized-Bed CFB and efficient supercritical once-through technologies as well as using oxycombustion to enable the capture of carbon before it is released. In fact they are construction the world's first supercritical CFB in Poland and the construction of a 240 Megawatt CFB boiler in Sweden designed to burn biomass materials.

Sporting a trailing PE ratio of 30, most analysts expect the company to grow between 20 and 40 percent depending on new contract wins. This variability in the growth rate will likely cause volatility in the price of FWLT' shares. Investors should look to buy on dips in price.

Flowserve ( FLS ) – Flowserve manufactures engineered pumps, valves and mechanical seals for fluid control systems. As the second largest producer of pumps and the third largest manufacturer of valves, it serves oil and gas, chemical, general industrial, power generation, and water treatment sector with operations in 70 countries in North America, Europe, Middle East, Africa, Asia Pacific, and Latin America. 

The coal and nuclear power generation markets are experiencing an increase in demand for Flowserve's products as they work to improve their efficiency and emissions. Also, the demand for cleaner burning fuels will increase the need for high quality pumps, valves and seals. 

In 2006, roughly 65% of Flowserve's business was generated outside the U.S., with a total of $3 billion in sales. The company also serves as an after-market services provider. Since margins have been shrinking, the company hopes to improve margins through its after-market services, which deliver higher margins. As of the second quarter 2007 the company's backlog is worth $2.08 billion – an increase of 17% over last year.

Geographically, Europe accounts for the largest chunk of Flowserve's revenue, while oil and gas were the top industrial application for Flowserve's products. Overall, earnings are up 80% over last year, and with the demand for energy, Flowserve's flow control pumps, valves and seals should growing sales from conventional as well as green sources. 

Fluor Corporation ( FLR ) - Fluor Corporation provides engineering, procurement, and construction and maintenance (EPCM) services worldwide for five segments: Oil & Gas, Industrial & Infrastructure, Government, Global Services, and Power.

For the second quarter 2007, Fluor's net earnings rose 44 percent to $96 million or $1.01 per diluted share compared to the year ago quarter. Revenue grew by 22 percent to $4.2 billion for the second quarter due to significant growth in the Oil & Gas and Power business segments.

Like other construction companies Fluor provides the engineering talent to help its customers meet strict emission standards in all of its projects. They use a variety of technologies to achieve the desired results and continue to improve on their capability. The company has a culture of committing to environmental, economic and social issues. Fluor should continue to benefit 

The Bottom Line

While many investors who are interested in the rush to green companies are chasing solar, wind power and ethanol plays among others, the engineering and construction industry may be in the best position to benefit in the long run from the focused effort to reduce emissions world wide. These companies may not be as exciting as the others, however, they offer more sustainable returns over time and they are all growing at very nice rates now as the demand for their services continues to expand globally. Investors looking for green plays should consider these engineering and construction companies.

 

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Hans Wagner Archive

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