Let’s take a ride on Washington’s energy reform merry-go-round. It’s a popular pastime with lobbyists and their clients, who never tire of filling politicians’ re-election coffers in appreciation of their efforts to restore tax fairness.

And sure, sometimes expediency simply demands that a certain sector or company get a little extra help, just for a year or two. And sure sometimes these temporary subsidies get renewed again and again. But that’s usually how we know it’s time to pass the hat and “level the playing field “ again.        

On Dec. 18, Senate Finance Committee Chairman Max Baucus (D-MT) issued a press release outlining his proposals for an overhaul of the country’s energy tax policies. Later that day came news that President Obama would nominate Senator Baucus to become the next ambassador to China — a position for which he has now been confirmed by the Senate. Baucus’ departure for China means that his energy tax reform proposal will be a longshot to win passage.

Sen. Ron Wyden (D-OR) will take over as Senate Finance Committee chairman, and he has indicated that tax reform is a top priority of his, as is extending many of the energy efficiency and renewable energy credits that expired at the end of 2013. Wyden will be succeeded in his position as Chair of the Energy and Natural Resources Committee by Sen. Mary Landrieu (D-LA).  

Wyden has spoken favorably of the proposals put forward by Baucus, and while they are unlikely to be passed in their current form, Baucus’ press release does help frame the issue:  

“Today, there are 42 different energy tax incentives, including more than a dozen preferences for fossil fuels, ten different incentives for renewable fuels and alternative vehicles, and six different credits for clean electricity. Of the 42 different energy incentives, 25 are temporary and expire every year or two. The credits for clean electricity alone have been adjusted 14 times since 1978 – an average of every two and a half years. Our current energy tax incentives also result in significant revenue loss. If we to continue to extend current incentives, they will cost nearly $150 billion over ten years.

Furthermore, our existing energy incentives provide different levels of subsidies for different technologies, picking winners and losers with no discernable policy rationale. For example, some clean energy production, such as generating electricity by capturing excess heat at manufacturing facilities, is ineligible for the production tax credit because it is not expressly listed in the code. Other types of energy production generating significant air pollution receive sizable tax subsidies.”

The problem that Baucus identifies is real and longstanding. Energy projects tend to take a long time, and they tend to be capital-intensive. As such, they require consistent energy policies. This is true whether the project is a wind turbine or an oil pipeline.

When politicians change tax rates or incentives every few years they risk fostering distrust, which will lead to a very conservative approach to spending by project developers. An example of this can be found in Venezuela, where Hugo Chavez greatly increased tax rates after international oil companies had invested heavily in the country. This caused many of the multinationals to stop investing in the country. As a result of insufficient investment, Venezuela has seen its oil production decline steadily despite having the world’s largest oil reserves.

In the US, Alaska governor Sarah Palin was cited as a major impediment in getting a natural gas pipeline built in Alaska because of her refusal to agree to long-term tax rates. Palin had already been nicknamed The Hugo Chavez of Alaska because of her energy tax policies in Alaska. Before oil companies would agree to invest in a $30 billion dollar pipeline, they wanted some assurance of their long-term tax rates so they could properly evaluate the project’s economics. Her refusal to commit to a long-term tax rate for the companies that would invest in the potential gas pipeline doomed the project during her tenure as governor.  

The same sort of tax uncertainty has harmed renewable energy projects. The Production Tax Credit (PTC) for wind power has been a huge driver of wind projects, but it has expired and been reinstated several times. Each time it expires, investment in wind power stalls. Expiration and subsequent reinstatement of a biodiesel tax credit has caused the biodiesel industry to plummet and surge.

Consistency in energy tax policy is important. Investors want to understand the rules of the game, and they want to be relatively certain those rules will not change after the game has started. If competing political factions could come to long-term compromises on various tax policies, it would go a long way toward creating the stability that project developers crave.

Political factions that strongly support certain energy incentives might agree to phase those out over time. For example, instead of seeing annual fights over certain tax incentives, perhaps they could be phased out over 10 years. Such a compromise would give developers longer-term certainty, while ultimately addressing the concerns of opponents of those incentives.

Of course the challenge is in getting broad agreement as to which incentives are needed. Some argue that none are and that the free market should decide. Others insist that the biggest incentives should go to renewable energy. The Baucus plan called for the elimination of tax credits deemed no longer necessary (e.g., certain fossil fuel subsidies) and a simplification of the remaining tax preferences. Baucus proposed basing the generosity of the incentive on how “clean” the energy source is deemed to be.

Baucus cites the government’s history of attempting to pick technology winners — a practice I have criticized in the past. I fully agree with trying to level the playing field, but the devil is always in the details. Who gets to decide whether one technology is “cleaner” than another, and thus more deserving of a greater incentive? There are many cases where a technology was deemed cleaner than it actually turned out to be, so we have to guard against adopting a solution that simply changes who is picking the winners.

Energy tax reform is seriously overdue. That is a sentiment shared by renewable energy startups and fossil fuel producers alike. Of course they differ on just about every particular and will have their lobbies ready to fight against changes deemed harmful to their self-interest. As a result, we will probably end up with what we have now — a hodgepodge of inconsistent energy incentives that often create uncertainty, discouraging big, long-term projects.

But as Wyden picks up the reform banner  we will watch closely where he attempts to lead and look out for the pitfalls and opportunities along the way.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Chesapeake Hit on Gassy Forecast

It’s safe to say Doug Lawler’s honeymoon at the helm of Chesapeake Energy (NYSE: CHK) has run its course.

As recently as three months, the new CEO was hailed as the company’s savior from the ravages of its borrowing addiction under founder Aubrey McClendon.

Now Lawler’s taken a hatchet to operating costs and to Chesapeake’s capital spending plans as well. And somehow the near future doesn’t look quite as painless as once hoped, nor as tidy.

Not coincidentally, Chesapeake’s stock, though still up more than 18 percent since lawler’s hiring on May 20, is also down nearly 15 percent from its November high. Our portfolio return on Chesapeake since recommending it just before Lawler arrived is down to 21 percent.

The catalyst for last week’s drubbing was the release of management’s outlook for 2014, which disappointed analysts with projected annual growth of just 1 to 5 percent in crude (but 8 to 12 percent adjusting for the effect of asset sales.) The Street was expecting something closer to 12 percent asset sales or no, and that difference will cost Chesapeake dearly on the bottom line, since crude remains the principal profit driver for drillers. Upcoming earnings results will also be hurt by the recent winter cold and its depressing effect on Chesapeake’s production.

But to focus excessively on these short-term factors and challenges is to lose sight of the lasting improvements Lawler is making in Chesapeake’s cost structure. The company set to deliver modest production growth despite divestitures and a 20 percent cut in capital spending (and a 60 percent reduction from the days when McClendon was living high on the hog.) Meanwhile, production costs per unit of energy are set to drop 10 percent this year, while per-unit administrative costs are to be slashed 25 percent.

Admittedly, Chesapeake will still need to sell $1 billion of assets this year to plug the gap between what it plans to spend and take in, but at least management is finally prepared to shrink to live within its means, with decisions on what to sell and what to keep based on profitability rather than empire-building.

So while the stock could suffer more weakness in the near term and profits in the first half of the year will probably not thrill, the longer term looks bright as Chesapeake rationalizes its prize holdings in the Eagle Ford, Marcellus and the Utica shale. The acreage under Chesapeake’s control is good enough to turn the cash flow positive over the long haul and to provide a nice return for buyers at these levels over the same extended time frame. Buy CHK below $28.     

Stock Talk

We encourage you to engage with our analysts and your fellow subscribers on our website. To ask a question or post a comment related to a particular article, please do so in the Stock Talk field at the bottom of that article.

Or, to ask a general question, please go to the main Stock Talk page found under the Resources menu for each publication.