On Wednesday I had the pleasure of speaking to the Indiana Energy Conference for the second consecutive year. Last year’s lineup of presenters was outstanding, but this year’s list was even better and included politicians and representatives from various lobbying groups and utilities.

In this e-zine and my subscription newsletter The Energy Strategist, I spend a great deal of time analyzing energy issues from both a national and global perspective. Along these lines, my talk at this year’s conference focused on global growth in energy demand and supply constraints, as well as the impact of the financial crisis on all things energy. But it was fascinating to hear how global issues and national policies impact a particular region, in this case the state of Indiana.

Several speakers at the conference noted that as a percentage of its economy, Indiana is the state with the highest weighting in manufacturing. In addition, the State is heavily reliant on coal for electric power and energy and, as a result, has some of the lowest electricity rates in the US. In 2009 the State of Indiana has an average retail electricity price of 5.85 cents per kilowatt hour for industrial customers. That ranks Indiana 17 out of the 50 US states, well below the national average of 6.95 and other regional manufacturing powers such as Illinois, Michigan and Ohio.

As you might imagine, Indiana has some grave and valid concerns about climate change legislation currently circulating on Capitol Hill–namely, the Waxman-Markey Bill that passed the House of Representatives in June by a slim margin and the Kerry-Boxer Bill unveiled earlier this week in the Senate. Indiana Governor Mitch Daniels highlighted some of the state’s alternative energy and conservation initiatives but came out very clearly against current climate change legislation making its way around Washington. 

Both climate bills currently under discussion would use a cap-and-trade system to gradually reduce US emissions of carbon dioxide over time. For those unfamiliar with cap and trade, the basic system involved setting a national target for greenhouse gas emissions and then issuing permits that allow a company to emit a certain amount of carbon. Companies that emit less than their target could then sell credits to firms that exceed their targets. Over time, the total number of tradeable allowances falls; declining supply would tend to push up the value of the permits and provide an ever-rising incentive to cut emissions.

It’s easy to see why a cap and trade system creates problems for state like Indiana. Manufacturing is, by its very nature, an energy and carbon-intensive activity. Putting a price on carbon would raise costs for manufacturers in industries like steel by forcing them to buy credits to offset their emissions.

One of the speakers at the conference was from steel producer ArcelorMittal (MYSE: MT), the largest steel producer in the US and the world. He highlighted the efforts the industry has undertaken to improve its energy efficiency over the past 30 years.  In particular, I was struck by one chart in his presentation showing that in 1950 it took 57 million British Thermal Units (BTUs) to produce a single ton of steel; today that figure has declined to around 11 million BTUs. On this basis, energy efficiency has improved by nearly one-third since 1990 alone. Thanks to its global presence, adopt best-practice technologies around the world to and further reduce emissions; Arcelor has a formal target of reducing its total carbon emissions by 8 percent from a 2007 baseline.

Despite these apparent successes, cap and trade presents some daunting challenges. From a US perspective one of the most obvious is that most domestic steel mills were built more than 30 years ago; it’s far harder to improve efficiency at older plants or adapt such mills for carbon capture and storage. Meanwhile, many plants abroad, particularly in developing countries, are newer and boast more-efficient technologies. This puts the US industry at a considerable disadvantage globally. The speaker indicated that there would be ample allowances out until 2025 or so to cover the industry’s needs, but after that it would become increasingly difficult to meet requirements and there would be a need to “reinvent the industry.”

Governor Daniels also discussed the issue of “green jobs” as it relates to Indiana. The idea is that jobs lost in industries such as steel and coal mining due to climate-change regulations could be offset by jobs created to build wind turbines and solar facilities. The governor noted that the state is creating green jobs, but that these positions are fewer in number and pay less than traditional manufacturing jobs. At least for Indiana, the prospect of green jobs appears to be a less-than-convincing solution.

This regional example demonstrates why it’s going to be extremely difficult, if not impossible, for the US Senate to pass a climate bill similar to Waxman-Markey. The health care debate is likely to consume Congress this year, putting off climate legislation into 2010, after the Copenhagen Summit in December. And next year is a mid-term election year–think of all those senators in states with heavy coal or manufacturing industries that won’t support a bill that could damage those industries, especially in the midst of an economic downturn.

More broadly, consider the case of countries like China or India that are heavily reliant on manufacturing and coal. It’s highly unlikely that these countries will agree to any sort of firm targets in coming years; the most likely outcome is a vague agreement to pursue green technologies.

At the conference there appeared to be two basic views on climate change legislation: oppose it outright or favor some form of cap-and-trade for fear the ultimate outcome could be worse. The most likely outcome in my view is a heavily watered down bill that offers plenty of concessions and incentives to the coal, nuclear, utility and natural gas companies.

From an investing standpoint, my basic take on all this is that the alternative energy companies tend to be overhyped as plays on climate-change legislation, while natural gas and nuclear tend to get too little attention. In addition, investors are, by and large, too focused on the potential impacts of carbon legislation on the coal industry over the long term.

The natural gas industry was the subject of considerable discussion at the conference, in particular, the potential for new gas supplies from nonconventional plays to keep US gas prices relatively low. Of course, current gas prices are far too low to justify drilling in all but the least expensive shale plays in the US. The monthly natural gas report, released on Tuesday, confirms that US natural gas production has started to fall sharply thanks to the decline in drilling activity. In addition, the flood of liquefied natural gas (LNG) imports that many pundits predicted just hasn’t materialized; in July, US LNG imports were still more than 50 percent below their 2007 highs.

I am looking for US natural gas prices to climb to over the USD6 per million British thermal units by early 2010. That level is enough to stabilize US production. And, at that price, clean-burning natural gas could become a far more important piece of the US energy pie. I suspect that if a US climate bill passes over the next six months, greater use of natural gas will be a key provision.