Tuesday, January 23, 2007

Legislative Lay-up

Some have viewed the inability of Congress to produce any meaningful legislation in recent terms as a consequence of the scant majority Republicans held in either the House or Senate. Yet there is widespread optimism that with Democrats taking over this term, that there will be reforms galore along several fronts from health care to energy to corporate reporting. The fact that the Democrat majority is even weaker than that previously held by the Republicans appears to have eluded some. In the Senate the majority is resting on the shoulders of a man currently in speech therapy. I hope the Democrats are not counting on Senator Johnson for any filibuster tactics!

This new-found confidence in Congress can be seen running through our coverage universe. For example, after a couple of earnings surprises Fuel-Tech, Inc. (FTEK: Nasdaq) has become something of a Wall Street darling in recent months. Fuel Tech develops and sells air pollution abatement systems for combustion boilers, which are popular with coal-fired power plants in particular. Earnings surprises in the last few quarters and a busy road-show schedule for Fuel Tech’s management have been key drivers for the stock price. Nonetheless, part of what may be encouraging investors is the change in leadership on Capital Hill that is expected to favor environmental protection.

Senator Barbara Boxer takes over the Senate Environmental Committee in what many expect to be a sea-change for environmental policy coming out of Washington. She replaces Jim Inhofe, a Republican senator from Oklahoma, who has been an outspoken skeptic of global warming theories. He apparently has other explanations for the widespread loss of frogs and other reptiles highly sensitive to temperature. Boxer on the other hand has made climate change a top priority. That topic alone could keep the Committee busy for the entire term.

Companies like Fuel-Tech are expected to flourish if legislation puts more pressure on air polluting power plants to reduce emissions. Power plants are a significant source of air pollution and would seem a likely target for politicians looking to make changes. Coal-fired power plants are responsible for nearly 60% of the sulfur dioxide, 18% of nitrous oxides and about 50% of the particle pollution in the U.S. skies. In addition, coal-fired power plants are the largest polluter of toxic mercury. The oldest plants are the dirtiest because they were grandfathered into the Clean Air Act passed in the late 1970s and have not had to meet pollution control standards. The thinking at the time was that these plants would be taken off line and therefore would never be a problem. Yet today most power plants are 30 to 50 years old and these are as much as ten times dirtier than the new plants.

Even if the new Congress, highly populated with environmentally conscientious Democrats, were to pass new legislation that would require these old plants to clean up, it is far from a given that this will lead to a dramatic increase in demand for air pollution abatement solutions. The economics of pollution abatement could probably drive the last nail in the coffin of these plants and they might finally be taken off line rather than outfitted with solutions like Fuel-Tech’s NOxOUT product as an example.

Accordingly, vis-à-vis my firm’s coverage of FTEK, we are maintaining a cautious view on Congressional action as a growth driver. Senator Boxer has also promised increased money for the Superfund program, a move which should accelerate and expand projects for hazardous waste cleanup, as well as action on standards for perchlorate contamination in drinking water. While developments along these lines could benefit other names in our coverage universe - American Ecology, Inc. (ECOL: Nasdaq) provides hazardous waste disposal services and Basin Water, Inc. (BWTR: Nasdaq) provides ground water treatment systems - we recognize it is a matter of timing as to when either company could see a meaningful increase in their top-lines.

The unanswered question is whether an enthusiastic majority on both sides of Capital Hill is enough to make up for the fact that a member of the minority party is sitting in the Oval Office. In my view, the real test for this Congress is yet to come. Congress has demonstrated little leadership strength in recent years. Democrats need to demonstrate their ability to craft and pass legislation that will get signed by the Republican president. Otherwise, it is just politics as usual. Accordingly, we believe it is a bit too early to call a “legislative lay-up” for our coverage universe.

We continue this topic in the next post when we look at stock market value and Washington politics.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research publishes research on ECOL, BWTR and FTEK.

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