A Pickup In The Market For Natural Gas & Clean Coal
TWST: Please begin with a brief overview of your coverage areas, including some of the specific names you follow.
Mr. Mattison: My coverage includes energy infrastructure and alternative energy, specifically natural gas vehicle and clean coal names.
TWST: There are various scenarios regarding the NAT GAS Act that we could see out of Congress before the end of the year. Which of those potential scenarios do you think would have the most positive impact on the companies you follow?
Mr. Mattison: The NAT GAS Act was introduced last year, and it is a comprehensive bill supporting the natural gas vehicle industry by creating or increasing the incentives for purchasing natural gas-powered vehicles, building stations and other industry development. The bill has gained substantial bipartisan support, with 145 co-sponsors in the House and seven co-sponsors in the Senate that range from very liberal to very conservative. So the support has been very strong; it's just been a matter of how this bill moves forward. Some of the proposed energy bills have included pieces of the NAT GAS Act, such as the Kerry-Lieberman Act, and this summer Harry Reid, the Senate Majority Leader, introduced his oil spill bill that included a number of key elements of the NAT GAS Act.
While his spill bill was never discussed on the floor mainly due to contentious issues surrounding oil spill liabilities, on September 22 Reid introduced another standalone bill called 3815: Promoting Natural Gas and Electric Vehicles Act of 2010, and he has scheduled a couture for September 17. While the support for the bill is there, the concern is the "pay-go," which is currently oil and gas pay taxes, and that has met with resistance. But the bills supports are looking for other pay-for mechanisms. We see the passage of the bill as a matter of when rather than if and expect it to massively jump-start the U.S. natural gas vehicle market, which has lagged the rest of the world considerably. The biggest benefit of the bill would be to double the tax credit or rebate for purchasing a natural gas-powered vehicle, helping to offset the incremental purchase price.
The biggest advantage of natural gas is its lower cost - saving a dollar or more per gallon versus gasoline. While a passenger car might use between 600 to 800 gallons of fuel per year, a bus or truck might use 10,000, 15,000, 20,000 gallons a year. So all of a sudden, if you can save a dollar, it becomes quite material. Further, these heavy fuel users tend to be fleet vehicles that dispatch from and return to the same base, thereby minimizing the need for extensive fueling infrastructure. While an operator will see significant fuel cost saving, the biggest challenge is overcoming the higher initial purchase price that can be as high as $60,000 for the larger-sized trucks. The 18-wheelers, the heavy-duty trucks, that incremental purchase price can be as high as $50,000 to $65,000.
There are credits in place, which are set to expire at the end of this year, that provide up to $32,000, but the NAT GAS Act or Harry Reid's bill would double that amount to $64,000 of the incremental purchase price for the largest vehicle. Having this credit will greatly shorten the payback period for the truck owners, bring more competitors into the space, and it will be just a huge boost for the industry. You have a number of fleets and operators ranging from everything from garbage trucks to city buses, but even regional freight haulers are all waiting and looking at this, wanting to do it but just waiting to get some certainty with it. So if that passes, that will set off a huge boon for the industry. That's where I sort of laid out the scenario because it has all the potential and support to do it. It's just trying to guess what happens in Washington can be difficult.
TWST: It seems like the support is there but the question of how to pay for it is the hindrance. Is the passage of the NAT GAS Act something we may be waiting on for a while?
Mr. Mattison: While it stands a very good chance of passing in the lame-duck session, it could push to the new Congress, which makes guessing the timing much harder as the balance of power will shift, and even Senate Majority Leader Reid is in a tight re-election race. So there are a number of moving pieces with it, but I still think it does get done. The support is there; it makes too much sense for this country. T. Boone Pickens has done a great job going out and laying those clear benefits out, and this is one of the few alternative energy technologies out there that make both environmental and economic sense, so it makes a big difference.
TWST: In the event that the bill does get pushed off, what are other potential opportunities on the horizon, particularly in the U.S.?
Mr. Mattison: The U.S. market won't be as strong, but it will still be good, and the areas where you'll see it will be in the municipal transit market. CNG buses have done very well and are about 25% of the overall buses, and I think that will continue. There are a number of big fleet conversions or fleet orders coming up in the coming years - Dallas, New York City, also Los Angeles - where they'll be ordering a number of buses. That market will stay strong. You'll also see it in the garbage truck market for multiple reasons. For one, this is a perfect application - they are heavy fuel users that will see significant fuel savings. It is possible to take captured land fill gas to power the trucks. And finally, the Cummins (CMI) Westport (WPRT)8.9-liter ISL G engine in the trucks is able to meet 2010 EPA emission standards without using an SCR unit, which many operators dislike. In terms of regional trucking, the market will see much slower grow in the event that there are no subsidies, as they are much more economically focused, and owners will find it challenging to put out the capital to do it in large scale.
TWST: As you said earlier, the U.S. lags the rest of the world in natural gas. What are the fastest-growing international markets and which companies are taking advantage of those international opportunities?
Mr. Mattison: One of the fastest-growing markets is India, both on vehicle conversions and also new OEM natural gas offerings, also parts of South America, Brazil and Argentina, which have traditionally been strong markets. But areas like Venezuela, Bolivia and Peru are putting a big push on natural gas vehicles and a lot of uptake there. Also China is also growing very rapidly, and in Southeast Asia recently Thailand and Malaysia have become a major market. The other market I would mention would be Iran. They don't have a lot of refining capacity despite having a lot of oil, so they're trying to shift over there. As well some of the markets in the Europe are seeing strong growth.
The best-positioned companies are Fuel System Solutions (FSYS), which is one of the leading vehicle conversions selling around the globe through its subsidiary BRC. The company has always been focused on the international markets, and it's very well positioned in all of those markets that I mentioned, particularly India. The other one would be Westport Innovations which is more focused on the larger truck engines. While they have a strong presence in the U.S., their Cummins Westport joint venture is gaining significant traction into China, South America and India. They also are developing an engine with Volvo (VOLVY), which will initially launch in Europe, and they recently started a joint venture with Weichai (2338), in China, which is the largest diesel engine manufacturer in the world. Clean Energy Fuels (CLNE) is also building an international presence, having recently acquired IMW Compressors, which makes compressors for stations and has a big presence overseas, notably China and Malaysia. However, CLNE is the most U.S.-focused of the group.
TWST: Aside from uncertainty surrounding the NAT GAS Act, what is the biggest obstacle facing the natural gas industry at this point?
Mr. Mattison: In the U.S. market, really the obstacle is the NAT GAS Act and the uncertainty around it. We've been waiting and waiting and waiting, so if you're an owner who is looking to purchase natural gas vehicle trucks, you're wondering, "Do I order now? But then if I order now, am I going to miss having better credits two months from now?" So basically it's frozen the market; everyone is sitting on their hands to see what happens, so that's a huge obstacle there. The other obstacle is the incremental cost, and that absolutely has to come down. This has been happening, but it needs to continue until the price of a natural gas engine and a diesel engine are about the same. A company like Westport has done a very good job in terms of lowering the price of their engines and taking cost out of it, and I think that will continue. They've recently signed an agreement with Delphi to make fuel injectors, which will help bring costs down, but then also the price of tanks need to come down. We've seen in other parts of the world, it's a bit of a chicken and the egg in terms of you need volumes to get to scale to bring the cost down. That's the biggest challenge, but the industry has done a very good job; they just need to keep working towards it.
TWST: What are the most important trends in the clean coal space right now?
Mr. Mattison: This is a space mainly focused on providing emission control technologies primarily to the U.S. coal producers and also, to some extent, in key international markets, China and India. It's a market that had a very difficult last three years - they were hit by the double whammy of the recession that resulted in declining power demands and lead to their customers, the utilities, pulling back spending as they ran their fleets less. At the same time, the two emissions rules - the Clean Air Interstate Rule and the Clean Air Mercury Act - were challenged in court, and both of them were thrown out in 2008, which put emission control spending in paralysis as it made it impossible to plan without knowing what the rules would be. So it's been two very slow years. However, that is changing since the market is coming back. Number one, power demand is picking back up, which is a positive, and we have new regulations being put into place by the federal government, and those regulations are being phased in over the coming years. So this market for those companies is really going to start to pick up because now that the utilities see what the rules are, now they will start implementing solutions to control it.
TWST: In which areas of energy infrastructure do you see the most opportunities? Which companies under your coverage are best positioned to benefit from those opportunities?
Mr. Mattison: On the power side, you're definitely seeing that some of the companies that I focus on will start to see a pickup after two very slow years. A company like Babcock & Wilcox (BWC) will benefit from that trend. Other areas on the infrastructure side offshore - and this is mostly almost 90% international - offshore oil and gas construction is going to be a strong area. But again, most of that's focused on the Middle East and Asia Pacific. Then I think domestically, the pipeline space and the transmission infrastructure are two areas where there will be a very strong amount of money spent in the coming years to keep those markets active.
TWST: What is your overall advice to investors in natural gas at this point in time?
Mr. Mattison: I see this as a long-term major trend being driven by low availability of natural gas and low prices of natural gas, and will continue to grow both internationally and also in the U.S. It's a matter of when versus if.
TWST: What are your top-rated names now and why?
Mr. Mattison: On the natural gas vehicles, my top pick is Westport Innovations. It has proprietary technology, is partnered with the leading engine manufactures, including Cummins, Volvo and Weichai, and finally their partnership business model gives them significant earnings leverage as volumes ramp up. On the clean coal side, my top pick is ADA-ES (ADES). The company has multiple business lines built around coal emission, and we think that all of them have significant upside. For mercury emission control, they provide the activated carbon injection systems used to control the mercury and also have a joint venture with private equity firm Energy Capital Partners that is producing the activated carbon used in the ACI systems. They also have a refined coal J.V. that recently signed a 10-year offtake agreement that will provide very strong cash flow and earnings, and could be expanded with new legislation. They also have a licensing agreement with Arch Coal (ACI) removing pollutants prior to combustion that, if successful, has the potential to be bigger than any of the other pieces of the company. And then finally they're doing CO2 work with the U.S. government, having recently won a $19 million contract to scale up their technology. As well, management is very well respected in the industry, and they have delivered on everything they have talked about doing in the past two years.
TWST: Thank you. (MES)
Note: Opinions and recommendations are as of 10/14/10.
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