As the United States looks to “green” its power fleet, electric utility companies are on the brink of a multiyear evolution that offers a long runway for growth.
A utility grows its earnings power through expansion of its regulated “rate base”—a term unique to the utilities sector and defined as the value of property on which a public utility is permitted, by its controlling authority, to earn a specified rate of return. Thus, the formula to calculate a utility’s rate base is a simple one, driven by “prudent” capital investment in hard assets rather than by top-line consumer demand. The rate base for an electric utility consists largely of its generation, transmission, and distribution infrastructure—minus depreciation. In general, a utility looks to add to its rate base faster than that rate base depreciates, which in turn allows for growth in absolute earnings and, thus, earnings per share. How is this affected by renewable energy?
The US has established ambitious 10-year decarbonization goals, and the Energy Information Agency predicts that reliance on renewable energy resources will grow from 10% of the current US energy mix to 39% by 2030. Renewables thus represent a significant capital-investment opportunity, and utility companies are accelerating replacement of their coal-fired fleets with cheaper, renewable energy-powered plants.
Until recently, the renewable energy realm consisted largely of independent power producers (IPPs)—everything from private firms to residential solar installations. Electric utilities acted mostly as buyers and sellers of IPP power purchase agreements (PPAs), but for a number of reasons held off on large-scale production projects that would add to their rate base. That paradigm has shifted dramatically, and given that capital investment underpins growth for utilities, anticipated renewable-resource development could propel the sector’s earnings growth solidly for the foreseeable future. I don’t think the utilities sector has experienced this large a step upward in capital expenditures since the advent of air conditioning.
While renewable energy plants continue to gain traction, renewable energy storage is another potential area of growth within the utilities sector. Currently, there is not enough storage capacity to house all of the energy that renewables are generating. Storage capacity, which increases reliability and availability, will need to increase substantially to meet the dramatic projected growth in renewables.
With the increased adoption of renewable energy generation, the earnings growth of the utilities industry is positioned to expand at a higher rate than the sector historically has seen. Federal and state regulation remains supportive, as governments continue to encourage companies to invest in renewable energy, and the public appears willing to pay for these more economically sound and greener options.
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