Government economic policies determine asset prices because policies set the “rules of game” that investors, companies, industries and countries must follow. A change in policy changes the rules of the game, thus changing how the players in the game act. Of all the government policy domains regulatory policy most clearly demonstrates this phenomenon, and of all the regulatory policy changes in history we are currently living through one of the most dramatic. Let’s refresh what we know about the power of policy by examining regulatory policy’s impact on a large, powerful and important U.S. industry, coal.
The Environmental Protection Agency under the Obama administration increased efforts to regulate the coal industry, using tougher environmental standards under the Clean Water Act to rein in destructive coal practices like mountaintop removal. Specifically, on July 6, 2011, the EPA issued new standards for power plants in 27 states that would sharply cut emissions. States from Texas to New York would have to slash 70 percent of sulfur dioxide emissions and 50 percent of nitrogen oxides from power plants, compared with 2005 pollution levels. Leaving aside the discussion of whether this was “right or wrong,” the EPA clearly changed the rules of the game for the coal industry. The government was quick to point out it was not mandating the closing of any power plants, but the laws of economics always work.
Importantly, this change in EPA regulation of coal burning power plants was enacted not by a law change or even a posted for comment regulatory change. Instead, the rules were changed by executive order from the president of the United States. Literally by the stroke of a pen the rules for an entire industry were rewritten.
The Dow Jones US Coal Index, comprising of all US companies involved in coal operation (production, mining, and cokeries) and transportation of coal, noticed. From 2009-2011 coal stocks enjoyed an astounding recovery of 200% from the 2008 financial panic. Things changed in July 2011, as the EPA rule changes discussed above were finalized. On July 6, 2011, the day of the EPA Cross-State Air Pollution rule, the coal index stood at 425. Today the coal index is at 42, a staggering loss of 90%.
The first two-thirds wipeout in the coal index happened from July 2011-June 2014 as the index dropped from 425 to 135 on the heels of the EPA rule change. For the first half of 2014 coal stocks took a break from declining and traded flat around 135. Remember, 2014 was a mid-term election year and the coal’s decline was put on pause in hopes of a better political outcome. The industry did not need to wait for the election outcome that year, because in June 2014 Obama’s EPA proposed the Clean Power Plan aimed at combating anthropogenic climate change (global warming.) The rule was designed to cut carbon dioxide emissions from existing coal plants by as much as 30 percent by 2030, compared with 2005 levels. The coal industry was once again in the cross hairs of a regulatory rule change.
From June 2014 through 2015 the coal index dropped from 135 to 21, a further 80% decline on an already decimated industry. An excellent lesson here is that once policy turns against an industry or asset class the effects are usually very durable. Even after losing two-thirds of its value from 2011-2014, it was still possible to lose another 80% of capital in coal investments.
It’s never too late to lose another 50%+ in your investment when the policy wind shifts against you. This was not one, two or five targeted coal companies crashing because of decimated earnings. This was the wipeout of an entrenched, powerful and large U.S. industry made up of many companies involved in many different facets of the coal business.
What’s next for coal? It will likely take a Republican president in 2017 to reverse the EPA’s agenda and Obama’s executive orders against the coal industry. In 2016 the coal industry’s future improved when the Supreme Court dealt a blow to the Obama administration’s landmark air quality rule, ruling the Environmental Protection Agency did not properly consider the costs of the regulation. In a 5-4 ruling on February 9, 2016 the justices ruled that the EPA should have taken into account the costs to utilities and others in the power sector before even deciding whether to set limits for the toxic air pollutants it regulated in 2011. The Van neck Vectors Coal ETF (KOL) is up over 100% since February 9, 2016 on this development. A Trump victory in November could ignite further investment in the coal space.
Bottom line: Government economic policies matter, and investors better pay attention to policy shifts’ impact on their portfolios. We at Kairos Capital Advisors call this “Policy Based Investing.” We implement our policy based strategy by managing client portfolios through our Registered Investment Advisory firm as well as providing weekly policy based asset allocation advice through our subscription based newsletter called “Reading the World.”
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