Financial Review

Monday, June 02, 2014 – Clean Power Plan

Clean Power Plan
by Sinclair Noe

DOW + 26 = 16,743
SPX + 1 = 1924
NAS – 5 = 4237
10 YR YLD + .07 = 2.53%
OIL – .31 = 102.40
GOLD – 7.80 = 1244.50
SILV – .05 = 18.86

 

The ISM got it wrong this morning. The Institute for Supply Management reported its May manufacturing index came in at a weaker than expected 53.2, but there was a software problem that didn’t properly reflect season adjustments; the ISM issued a revision; the May index was 56.0; but for some reason, that wasn’t correct, so they issued another revision. The May manufacturing index was 55.4; that’s the number and they’re sticking with it. Embarrassing? Yes.

 

Meanwhile, stocks and bonds were all over the board. Stocks fell into negative territory early on, but bounced back as revisions were issued. Bonds are hyper sensitive to economic growth, and the yield on the 10 year note moved higher and stayed higher, despite the initial numbers and the revisions. And if you look past the revisions, and you should, because it appears to be nothing more than an honest mistake, caught quick and corrected; the bottom line is a pretty strong number for manufacturing, more or less in line with the idea of a second quarter bounce in the economy.

 

The bigger story this week will be the jobs report on Friday. It is widely expected the economy added about 200,000 to 215,000 jobs in May, which would be down from a very strong report of 288,000 net new jobs in April. The unemployment rate is expected to tick up from 6.3% to 6.4% as more people enter the labor force.

 

We also expect some big economic news out of Europe this week, and we’re likely to see a small announcement instead. You will recall that European Central Bank President Mario Draghi announced back in the summer of 2012 that he would do “whatever it takes” to save the euro. And then he spent the following two years doing nothing. This week he’s expected to actually do something, specifically he’s expected to unveil a package of measures to fight deflation. Analysts expect the ECB to cut both its main interest rate and reduce its deposit rate to below zero, meaning the central bank would charge lenders to hold money with it overnight. Although any reduction will be modest, a negative deposit rate has never been introduced by a major central bank; and the thinking goes, this will force the banks to start lending.

 

It doesn’t take much to see the flawed logic. Many countries in the Euro periphery are still struggling with Great Depression level unemployment. As long as unemployment remains as high as this, it’s nearly impossible for countries to generate the internal demand necessary for durable growth. The biggest obstacle to a bold move would seem to be Germany, which is enjoying a pretty strong economy, but even there, the inflation rate has dipped down to 0.6%. The ECB seems to think a little fine tuning will right the ship and then a rising tide will lift all boats. Doubtful.

 

As expected, the EPA today issued the “Clean Power Plan” proposal, calling it “a commonsense plan to cut carbon pollution… Climate and weather disasters in 2012 cost the American economy more than $100 billion,” the agency says in a document accompanying the proposal.

 

EPA Administrator Gina McCarthy said: “We don’t have to choose between a healthy economy and a healthy environment. Our action will sharpen America’s competitive edge, spur innovation and create jobs.”

 

The regulations would force power plants to cut carbon dioxide emissions by 30% by 2030. The rules would set guidelines that states could choose how to follow. Under the plan, each state would have its own goal within the overall national pollution reduction effort. That’s an attempt to be politically and practically flexible in implementation. The EPA would set targets for each state for carbon emissions reductions. Then state governments would come up with their own plans for hitting these targets. The proposed regulation in essence gives them four different approaches they could try. They could renovate existing coal-fired plants with newer, more clean-burning technology; they could switch coal plants to natural gas, which produces much less carbon; they could try to persuade residents to be more efficient in their use of electricity; or they could band together with other states in a cap-and-trade network for emission reductions.

 

In a cap-and-trade network, companies would buy and sell permits allowing them to produce a certain amount of carbon emissions. Clean producers would be the sellers, while dirtier producers would be the buyers.

Almost a third of America’s carbon emissions comes from electricity generation. EPA officials concede some of the dirtiest power plants now operating, such as older coal-fired plants, will end up shuttered as the nation shifts its reliance from traditional fossil fuel sources to cleaner alternatives. Coal supplied 37% of US electricity in 2012, compared to 30% from natural gas, 19% from nuclear power plants, 7% from hydropower sources such as dams and 5% from renewable sources such as wind and solar. By 2030, just over 30% of US electricity will come from coal and about the same amount from natural gas, with wind, solar and other alternative sources providing about 9%.

 

According to the EPA, the proposed new rules would reduce carbon pollution by the same amount as removing two-thirds of all cars and trucks form American roads. It put the cost as high as $8.8 billion a year, but noted health gains such as fewer premature deaths and respiratory diseases along with other benefits would be worth tens of billions of dollars to the US economy. Recent analysis quantifies the benefits in health, air quality and clean water at $63 billion a year. Since 1970, every dollar invested in compliance with Clean Air Act standards has yielded $4 to $8 in economic benefits.

 

Will this move actually clean up global pollution? Not really. No matter what the US does, global emissions will keep skyrocketing in the near future. This is because most of the rise in emissions is being driven by China. China’s carbon pollution has soared in the last 15 years, and is now about double the US level. The rest of the increase has come from oil-producing countries and from other, more slowly developing Asian nations; but China overshadows all of the other sources.

 

American per capita emissions, of course, are still more than twice as large as China’s. And the simple fact is that we won’t get far trying to tell China they have to cut emissions if we aren’t willing to cut our own emissions. Of course, if we unilaterally cut our emissions, that doesn’t mean China will be willing to follow our lead. Self-restraint might do nothing more than push down the price of high carbon energy sources, allowing China to burn more for less. What this move really does is position the US as a leader in cleaner energy technology, and even if we can’t export natural gas to China or many other parts of the globe, we could export cleaner energy technology and expertise.

 

One way to do this is to tax carbon intensive imports; something not included in today’s proposal. The US is still China’s most important export market, so a US carbon-import tax will provide a huge incentive for Chinese companies to reduce emissions.

 

Another specific not included in today’s proposal would be to implement a carbon tax or equivalent here in the US. This won’t cut worldwide emissions enough to make a dent in global warming, but the funds could be used to spur research and development into things like gas, solar, wind and energy efficiency. We should think of carbon taxes mainly as incentives for the private sector to discover all the carbon-cutting technologies, and fund the research that will make green energy cheaper than coal.

 

Fortunately, renewable energy is up to the challenge of replacing those dirty fuels. In just the last three years, solar panels have gotten 60% cheaper and the price of wind energy has fallen more than 40%. Far from being expensive, clean energy is already beating both coal and natural gas on price in many parts of the country.

 

Coal and oil are low tech fuels whose time has passed, just as surely as the days of using whale oil to light our lamps, but the transition won’t be easy. The apprehension in coal country to leave this current path is understandable. We would all feel it if we were in their shoes. Outsiders can’t ignore the plight of the families and the affected communities. And there will be massive political opposition, especially from the politicians backed by coal and big oil, which is most of the politicians. And most of these new regulations won’t go into effect until 2015, and there will be legal challenges, but the future is changing.

 

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