Ronald Reagan once quipped, “The nine scariest words in the English language are ‘I’m from the government and I’m here to help.’” Though many government programs start out as good ideas to help the citizens and much good is done, sometimes parts of the bureaucracy can hurt or even outright kill businesses.
I witnessed this first hand several years ago when the infamous “Cash for Clunkers” program was enacted. The plan was to take older, less fuel-efficient cars off the road and allow newer models to replace them. The program created a spike in new car sales, but it had bad consequences as well.
One of these was a used car dealer I had financed. The company provided low priced used cars that were primarily bought by lower income folks who needed a car for essential transportation. Cash for Clunkers provided money for those who turned in their old car. These cars were then junked and added to the landfills of our country. Over 600,000 used cars were taken from the road with the program.
The program raised the price of used cars with the decrease in supply. Soon my dealer was paying 50-100% more for the same used car that he did prior to the program staring. Margins were squeezed. I watched as the dealer closed down one of his locations after the other, until both he and his brother, who was also in the same business, eventually filed bankruptcy.
Today, a recent ruling by the EPA is mandating that carbon emissions be cut by 30% in fossil fuel burning plants by 2030. This seems to impact the coal industry the most, which supplies around 35% of all the electricity in the US. States have to come up with plans to make plants more efficient or to change to other forms of power generation. This mandate, if it is allowed to continue, will create winners and losers.
Winners can be any electrical generation that produces less carbon. Some examples are solar, natural gas, and nuclear. Companies that produce power inn these ways or new technological achievements that can lower the production price per kilowatt hour can achieve superior financial results. Also conservation methods and companies that assist clients to conserve or produce their own energy can also see increased demand.
Losers start with coal producing states. If no other market is found for the coal, they will see a severe drop in economic activity and jobs. Other losers can be businesses and consumers that use electricity. If no other alternative source of affordable energy is found, these users can expect to see an increase in their utility rates. Higher utility rates could cause prices to increase. If no other dependable alternatives are found, then some areas could be burdened with interrupted electrical supply.
If these utility rates do increase substantially, the credit analyst must ask if the business has the ability to weather increased utility and other costs or if the company can pass on those costs and keep their margins in place. Is it possible this could become a new risk that must be underwritten for? If the company uses a lot of electricity, this cost factor should be considered. We often stress test for increased interest rates; we may need to stress test for increased utility costs.
What if a company invests substantial capital into some form of alternative energy like solar to combat the higher energy costs? I had banker friends who financed a large solar installation on the roof of a cold storage warehouse of a food service company. The firm expected to see a reduction in its electrical bill by nearly 75%. The actual results were less than 10%. The firm failed to realize that if their electricity usage spiked over a certain threshold, a demand rate would kick in from the utility for the remainder of the billing period. So one really hot day in an otherwise mild summer month would wipe out the cost savings from the solar.
Now we are in a time where solar cells are coming down quickly in price and also are gaining efficiency. If the same company were to install the solar system today, perhaps they would begin to see greater gains in their savings. These advances in technology are sometimes hard for a credit analyst, and even a business to understand exactly what the economic benefit would be for an alternative energy system. It becomes a problem in a company where cash flow is already tight and the system requires loan financing. Any way you look at it, the advances in technology and changes from governmental laws and regulations present large challenges to the lender.