The clean energy transition appears to be gaining momentum. The economics make sense, and the need to improve grid reliability, ensure energy security, and combat climate change could be long-term tailwinds for utilities.
Regulated electric utilities are key players on three major fronts in the energy transition.
- First, they help to decarbonize the economy by adding renewable energy capacity.
- Second, they would facilitate adoption of electric vehicles and the electrification of other energy-intensive industries.
- Third, they are well positioned to provide other necessary solutions, including energy efficiency and distributed energy resources.
A transformation of this scope is complex, capital-intensive, and will take decades.
Let’s explore what these massive changes could mean for the industry and investors.
Adding wind and solar power can help create value for electric utilities and their customers. It also can curry favor with regulators. This is a prime example of the utility flywheel.
Here’s how renewables can drive this flywheel.
Unlike coal- or gas-fired power plants, wind and solar farms replace recurring fuel costs with a fixed investment.
These projects expand utilities’ rate base, or the capital investment on which the utility can earn a rate of return. So capital spending should translate into earnings and dividend growth for utilities.
These cost savings can also help to lower customers’ bills or keep them flat. And that fosters good relations with the regulators that set the rates of return that utilities can earn.
Still, I expect renewables adoption to come in fits and starts. This is because of a mix of technical, economic, and regulatory hurdles.
Here’s an example.
Wind and solar are intermittent sources of power. Once renewables reach a certain proportion of generation capacity, the risk of a mismatch between electricity supply and consumption increases. Solving these potential service outages through investments in storage and grid upgrades will be expensive.
Utilities would likely benefit over the long term from the push to electrify transportation and other energy-intensive industries.
One advantage of electric vehicles is that they can draw on different energy sources. With internal combustion engines, oil products are the only real options.
Widespread electric vehicle adoption will take years. Electrifying residential and commercial heating or using renewable power to generate clean hydrogen will likely take longer.
More electricity demand can translate into improved affordability. That’s because the fixed cost is spread over a higher amount of consumption.
I prefer electric utilities whose capital spending plans should drive earnings and dividend growth at the high end of the range for the sector. These companies are usually well managed, have strong operations that provide reliable and affordable electricity, and good relations with regulators.
Valuation is also critical. Utility stocks sometimes get expensive when there is a flight to safety. Some of my favorite setups occur when I identify a mid-tier utility that is making changes to strengthen its growth profile.
Government policy is also important. I am closely watching developments related to federal tax credits for renewable energy. Potential tariffs on solar panels and free trade issues are other areas of near-term concern.
- The energy transition should give regulated electric utilities opportunities to grow their rate base, earnings, and dividends through clean energy projects.
- Removing the recurring fuel supply costs associated with legacy power plants could help renewable energy projects to lower customers’ bills or keep them flat.
- We seek to identify utilities that we believe can compound value by consistently growing faster than their peers. Valuation discipline is also critical.
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