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By Jeremy Glaser | 03-14-2011 05:50 PM

Energy Sector Likely to See Biggest Impact From Earthquake

Morningstar StockInvestor editor Paul Larson says the events in Japan will shape the fortunes of energy stocks, from incumbent nuclear players to coal producers.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As the people of Japan continue to cope with the devastating earthquake and tsunami that hit that country last week, the impact of that event is reverberating across several industries across the globe. I'm here today with Paul Larson. He is Editor of Morningstar StockInvestor to take a closer look at some of these industries and see what the impact could be for investors.

Paul, I know our thoughts are with the people of Japan today, but I was hoping that we could get your thoughts on some of the industries.

Paul Larson: Sure, I am glad to be here.

Glaser: The thing that comes to mind first is insurance. Obviously there is a going to be a lot of losses, pretty catastrophic. What insurance companies do you think will take the brunt of these losses?

Larson: Well, it is worth nothing that this is probably going to be one of the largest loss events in insurance history. Katrina was by most estimates a $50 to $60 billion event all in, and some estimates today are that this could be a $15 billion to $20 billion event just from the earthquake alone, let alone the tsunami. We're talking for sure at least a top five event and maybe very near the top. And for companies that have insurance exposure, reinsurance exposure, they are obviously going to be writing some very large checks in terms of claims that they are paying out over the next several months.

But when you look at the history of the insurance industry, we're probably going to see a handful of the smaller players get wiped out or nearly wiped out by this event, but the much larger players like Berkshire Hathaway, this is probably not going to move the needle at all. Whatever they are going to give up in terms of claims payments in the short-term, they are going to more than make up in higher premiums that they are going to collect in the very near future. This is what happened with Katrina and I think this is what we're going to see here with this event.

Glaser: You're not expecting a mass disruption in the insurance industry. People will still be able to get insurance for other catastrophic events?

Larson: Absolutely. Of course, the prices that they are going to have to pay from this point forward are going to be much higher, but I think the insurance availability is still going to be unaffected essentially.

Glaser: One of the things we've been tracking closely is the partial meltdown in the nuclear plant in Japan. Can you talk to us a little bit about what the impact in the energy sector could be?

Larson: Well, I think that there is going to be a very large impact from these events at this plant. You just look at what happened in the Gulf of Mexico with the oil spill that we had last year. This is one spill that we had out of 3,000 offshore rigs and we saw a drilling moratorium that is still in the process of being lifted despite the fact that we have $100 oil and so obviously a very large impact from that oil spill. I think we're going to see a very similar impact with the nuclear industry. In that, we're going to see politicians and the public really have some second thoughts about going forward and improving the new nuclear plants around the world.

So I think that the most obvious impact is that the so-called nuclear renaissance that was underway, I think is going to be pushed off a number of years, and frankly may never happen at least in our life times if we continue to have events like this. I mean you look at Three Mile Island that happed in 1979 and here we are 30 plus years later and we still haven't had a new nuclear plant built in this country. And if we have a negative event in Japan, again, I think the worldwide impact is going to be material.

Glaser: So, certainly, that's got spill over to the United States. How would that impact someone like Exelon, one of the incumbent players in that industry?

Larson: Right. Well, there are certainly losers and winners, and Cameco is really getting hurt following this event and that probably make some sense. If the future growth, the long-term future growth rates of the company are going to be significantly lower. But then when you look at the incumbents like Exelon, I think this is actually a mild net positive, Exelon is the largest operator in nuclear plants in the United States.

If all of a sudden you're not going to have any new nuclear plants in this country for several decades that only entrenches the position of the incumbents like Exelon. So, I think it's actually going to be a mild net positive for Exelon.

Glaser: There was lot of companies that make their living in servicing and building new reactors. Obviously it is probably negative for them, do you think this is – we're not going to see really any building or just going to see huge slow down?

Larson: I think we're going to see a very large slowdown as the politicians and the public discuss the pros and cons of various sources of energy, and it's worth noting that all source of energy have those pros and cons. It's not nearly as black or white a situation. But anyways, yes, Shaw Group is one example of a company I can think of that has exposure to nuclear build outs around the world that is probably going to see a step change function in its growth rate to the downward side.

Glaser: Paul, what about other energy companies?

Larson: Well, we're seeing some interesting dislocations in the natural gas industry because Japan is the largest importer of liquefied natural gas and with these nuclear plants offline and a lot of the ports seeing disruptions also, so they can't import coal – Japan is a very importer of coal – Japan is just going to be sucking up that much more LNG from around the world. So, we're going to see natural gas prices worldwide rise, which is good for all natural gas companies around the world.

Another area in energy that we're watching where there is probably more of a mixed impact is coal. There is two types of coal. There is met coal, which is used in making steel and there is thermal coal, which is used in power plants. Japan is a very large producer of steel. So, you're probably going to see a very significant reduction in met coal.

But then the thermal coal is a positive, because again we're probably going to see more thermal coal used both in the short-term and more importantly, in the long-term as if nuclear is going to play a much reduced role in future energy supplies. That means that coal is going to be that much larger and so, no surprise that we're seeing in number of the coal companies rally today.

Glaser: Certainly, a lot of money is going to be spent on rebuilding the infrastructure in Japan, is there anyone who is well-positioned to take advantage of that?

Larson: Sure. One company that I can think of is Caterpillar. And this is a company that the equipment is obviously going to be needed in Japan and also Caterpillar might benefit because their primary competitors are both Japanese firms and we're seeing a number of disruptions across numerous Japanese industries. So, this might give Caterpillar a more of an edge in a market such as China, where they are competing really head-to-head with these Japanese firms.

Glaser: Paul, as we continue to watch these events unfold, certainly it seems that the impact of this event could be pretty far reaching and could go on for quite some time.

Larson: I would certainly agree with that statement.

Glaser: Thanks for talking with me today

Larson: Thanks for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.

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