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Washington Watch

Utility Stocks and Politics

By Roger S. Conrad, on Jun. 20, 2016

Election results can have consequences for investors, which is why Conrad’s Utility Investor always makes a point of previewing what’s at stake in the presidential and key gubernatorial elections.

The presidential election cycle involves a barrage of political advertising and media coverage that can play with your emotions and distract from what’s important for your investment portfolio.

With a highly contentious presidential race likely to stoke strong emotions, investors should keep a level head and focus on what can actually change with election results. Above all, remember to bet on probabilities, not your personal politics.

Take energy policy. Americans enjoy the lowest prices for heat, gasoline and electricity in many years. Air quality has also improved, thanks to low-cost natural gas taking market share from coal.

Sen. Bernie Sanders, recently vanquished in the race for the Democratic presidential nomination, proposed an outright ban on hydraulic fracturing, a well-completion technique that has helped to fuel the shale oil and gas revolution.

However, investors shouldn’t expect such an extreme outcome if Democratic nominee Hillary Clinton wins the election. Although Clinton might push for tighter regulation of water usage and wastewater disposal, we doubt the pragmatic presidential candidate will introduce rules that would undercut the economics of producing gas in the Marcellus Shale and other prolific basins.

Despite all the rhetoric about environmental regulations killing coal, an abundance of low-cost natural gas explains why electric utilities have shifted from coal to gas.

Donald Trump can talk tough about saving jobs in the coal industry, but declawing the Environmental Protection Agency (EPA) won’t address the market factors that have driven coal-to-gas switching among electric utilities.

Nor would a Trump administration have much of an influence on the adoption of renewable energy, though the Republican presidential nominee could slash federal funding for energy research and seek to repeal tax subsidies for wind and solar power.

For one, the private sector will continue to plow money into renewable-energy research and development, while individual states and foreign governments also provide funding.

And recall that sizable majorities from both sides of the aisle last year voted to extend tax credits for new wind- and solar-power capacity. Renewable portfolio standards set at the state level, not federal mandates, have also helped to drive the adoption of clean energy.

Republican presidential nominee Donald Trump has boasted that he would approve the cross-border leg of TransCanada Corp’s (TSX: TRP, NYSE: TRP), after taking a cut for the US government.

TransCanada would benefit from the approval of this long-delayed pipeline. However, the company’s existing project backlog and pending acquisition of Columbia Pipeline Group (NYSE: CPGX)—which will give the firm a new growth platform in the Marcellus Shale—are arguably more important upside drivers.

Forget the rhetoric and bombast. Regardless of how this presidential election pans out, don’t expect much to change for energy companies.

Gubernatorial Elections

The 12 gubernatorial races are a different story. Governors appoint the regulators who set the rules for utilities operating in their states, including the assets in which they can invest and what returns they can earn.

Relations between state regulators and utilities are the friendliest in decades. The question is whether the populist rhetoric in the air will translate into real change.

Some of the flash points for utilities include potential rules governing the adoption of solar power, the fate of nuclear power plants struggling to compete in unregulated markets, responses to the EPA’s Clean Power Plan and approvals of pending acquisitions.

Investors who own utility stocks should focus on the state elections with the greatest odds of a different party entering the gubernatorial mansion: Missouri, New Hampshire and North Carolina.

The regulatory climates in Missouri and New Hampshire are best described as “uncertain,” while utilities in North Carolina have thrived during Pat McRory’s term in office—one of the benefits of having a 28-year employee of Duke Energy Corp (NYSE: DUK) in the governor’s mansion.

What’s at stake in Missouri? Key issues include the approval of Algonquin Power & Utilities Corp’s (TSQ: AQN, OTC: AQUNF) proposed acquisition of Empire District Electric Co (NYSE: EDE) and whether Missouri regulators have jurisdiction over Great Plains Energy’s (NYSE: GXP) purchase of Westar Energy (NYSE: WE). There’s also the matter of developing a plan to modernize the state’s aging gas and electric distribution systems.

Duke Energy Corp will close its pending acquisition of Piedmont Natural Gas (NYSE: PNY) long before the November election. But a Democratic victory in the gubernatorial race could saddle the company with stiffer penalties and higher clean-up costs for pollution from its coal-ash ponds.

Should investors lighten up on Duke Energy because of this political risk? Such a move would be premature when you consider how much can transpire in coming months and the time it takes to change the make-up of public service commissions. And Duke Energy offers exposure to favorable demographic trends as well as growing demand for natural gas and renewable energy.

Valuation Concerns

Elevated valuations remain a bigger concern for the utility sector than the upcoming election. Above-average dividend yields and the increasing likelihood that the Federal Reserve won’t hike interest rates this year have prompted investors to pile into utility stocks.

Meanwhile, the rally in oil prices has lifted all boats in the energy sector, including the worm-ridden ones that had deservedly take on water. US equities also look expensive when you consider the weakness in the economy and signs of technical fatigue.

This election will have consequences for energy and utility stocks. But stretched valuations are a far more pressing concern for investors.

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