Building renewable power generation and interconnecting it with the existing electric grid will be a catalyst for rising earnings and dividends for many electric utilities.
Utilities grow by investing money in excess of depreciation, and clean energy provides an opportunity to invest significant amounts of money. Many will replace existing generation with wind and solar while also lowering customer bills.
Investment will likely be greater than $100 billion over the next 15 years, creating a multi-billion dollar income opportunity for the industry.
Utilities generate net income by earning a rate of return on their asset bases. That rate of return, typically a 10% return on equity, is set by a regulator, so that the best way for a company to increase its earnings is to build its asset base.
The tricky part, though, is that the regulator has to approve all additions to the asset base. Any asset that a state commission deems unnecessary could be disallowed, meaning that the utility would earn no return.
One great thing about renewable energy is that it is popular. Several states are requiring utilities to procure up to 50% of power from clean sources.
Utilities know that reasonable investments in renewable generation will be seen as necessary by the regulator, and thus, they can plan on long-term steady additions to asset bases and consequently earnings and dividends.
Generally, the goal for every utility management team is to provide safe and secure power at the lowest possible cost.
Coal makes up a large part of the generation fleet because the plants can be run 24 hours per day, the United States has massive supply, and the fuel is cheap. Until recently, coal provided the cheapest form of power available.
For a utility whose mandate is to make sure that power is available whenever needed at the lowest price, coal was a great option.
The economics of coal have changed, though. Solar and wind generation costs have declined rapidly.
Today, the cheapest form of power available anywhere in the United States is from wind generation located in the Midwest. Solar in the Nevada desert is close behind.
A utility can reasonably retire coal plants and replace them with renewable generation and lower the cost of delivered electricity to customers. The effect of this is that last year the United States installed 16 gigawatts of clean energy, while about 12 gigawatts of coal power were retired.
Clean energy is expensive to install but has almost no continuing expenses once the plant is running. This is actually great for utilities.
Utilities earn a return on invested capital, but all operational expense is passed through to customers. Clean energy shifts all expenses to the capital side on which a utility earns a return, so from an investor perspective, a 100-megawatt wind farm provides greater earnings and dividend growth potential than a 100-megawatt coal plant.
Utilities will also have to invest billions of dollars into infrastructure to support its changing electric grid. Back-up natural-gas generation or batteries will be needed when wind and solar aren't available.
Peak solar generation happens around 3 p.m., while peak wind supply is at night. The problem for the grid is that peak demand occurs between 5 p.m. and 8 p.m. when most people come home from work.
The grid will need more transmission to import power from other locations in the United States that have excess power supply. It will need infrastructure to handle changing directions in electric flows as more electricity is sourced from rooftop solar panels and small farmland-based wind farms.
It will need better software and technology to handle constantly changing generation sources. All these investments will support rising earnings and dividends.
Utilities in the United States need to add 60 gigawatts of clean energy just to comply with state renewable mandates. Many more gigawatts could be added as solar and wind prices fall.
Those initial 60 gigawatts will cost about $120 billion, so the total investment opportunity is likely many multiples of that value. Replacing older generation with clean energy will be a source of growth for many years.
This article is commentary by an independent contributor.