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Four challenges that will shape electric utilities this decade

Derek Daly is Director of Investments & Capital Markets for CleanCapital.

Electric utilities, traditionally known as defensive investments with below average market volatility, are dealing with several new challenges that not only add risk and uncertainty to the sector, but will dramatically change their business model over the next decade.

As shown below, for the past 20 years, total returns from utility companies in the S&P 500 have exceeded those of the entire S&P 500 for all periods except the 10-year mark. Despite rapid growth in the technology sector, driven by titans such as Apple, Amazon, Alphabet, Microsoft, and Facebook, utilities have dominated the index based on total returns.

Today, utilities continue to maintain their reputation for reduced risk. Leading investors and publications have reported about the “stability that comes from a highly regulated industry,” that “utilities are among the lowest-risk securities available,” and are “companies offering an essential service on an exclusive basis”.

While historically valid, supportive statements like these ignore or significantly underplay four major challenges electric utilities are facing today.

1. Declining Energy Consumption

Over the last decade, the U.S. reduced its energy consumption by 2% while population grew 6% (306.8M to 325.7M) and GDP grew 15%. We are clearly doing more with less energy.

This divergence of energy use from population and economic growth reflects improvements in both energy efficiency and productivity. The ratio of GDP to energy consumed grew 17% over the last decade, a major shift for an industry founded on the assumption of ever-rising energy demand.

BNEF 2018 Sustainable Energy in America Factbook graphs showing energy consumption, GDP, and energy productivity.

2. Expense of Repairing and Replacing Infrastructure

Even as  energy consumption declines, a record amount of new capital has been earmarked to replace aging equipment, improve reliability, and deliver renewable generation. In 2017, Bloomberg New Energy Finance reported that investor-owned utilities and independent transmission developers increased investment to an estimated $22.9B. This is 10% more than 2016 levels and 91% over 2011.

Josh D. Rhodes with the University of Texas estimates the average age of power lines and transformers is 28 years old and the average age of generation assets is 30 years old. The cost of replacing these assets is $4.8 Trillion. To put that into perspective, using non-inflation adjusted numbers, if electric utilities continued pace with 2016 spending, it would take just under 231 years to complete.

3. Mounting Costs & Liabilities from Climate-Related Disasters

PG&E filing for chapter 11 is being called the first climate change related bankruptcy, with recent announcements coming as a shock to many in the energy and investment communities. The company faces enormous potential liabilities from accusations that safety lapses and inadequate maintenance caused a string of disasters in California. While Cal Fire reported last Thursday that a private electricity system was to blame for the 2017 Tubbs Fire, investigations of at least a dozen other fires in 2017 and the Camp Fire in 2018, are still ongoing.

The risk of property damage and personal injury or death from fires tied to utility equipment has been exacerbated by prolonged droughts fed by climate change. While the company asserts that it has increased efforts in recent years to maintain equipment and perform preventative action, especially tree trimming and brush removal in areas that are at high risk for fires, the company has also repeatedly been cited by state auditors for completing work behind schedule.

PG&E’s situation, while extreme, is not unique. For example, in 2012, Hurricane Sandy cost New Jersey utilities $1.8 billion in repair and response costs. As climate change continues to impact the  environment, utilities will be forced to react to a world in which extreme weather is the new normal: a costly proposition.

4. Rapid Growth of Distributed Energy Resources

GTM Research in a 2018 report highlighted the “explosive growth” of distributed energy resources and the specific technologies behind the disruption: distributed solar, energy storage, smart thermostats, electric vehicles, and small-scale combined heat and power (below 50 MW). In 2017, these five classes contributed 46.4 GW to the U.S. summer peak, or about 6%, researchers noted. GTM anticipates this will more than double by 2023, to 104.2 GW of flexible capacity.

As the trade journal Transmission & Distribution World describes: “The century-old, one-way electricity delivery model that has been serving the utility industry traditionally, is proving to be inadequate to support the rising demand and diverse energy options being explored by today’s consumers.”

Time for U.S. Utilities to Transform

Together, these four challenges have compounded to drive energy prices higher. Over the last decade, some states experienced increases as high as 40% in both residential and commercial prices. Additionally, these rates are likely low given this past decade’s commodity prices

From an investor’s perspective, this is a sector that is facing unprecedented challenges. How does a utility forecast climate-related disasters, especially in states like California with such strict liability laws? Can we simply pass these costs onto the customer rate base? If so, how do we think about the substantial growth of cheaper alternatives coming in the form of distributed resources? If “utilities in general are as safe if not safer than they’ve ever been”, investors need to ensure these challenges are being addressed through diligent resource planning and creative solutions that don’t immediately seek to pass costs on to the consumer.

Working with innovators at CleanCapital

I’m excited to announce the selection of my co-founders Thomas Byrne and Jon Powers to the inaugural Solar 40 under 40 list from Renewable Energy World. We founded CleanCapital in 2015 to make it easy to invest in clean energy. Since then we’ve built a proprietary technology platform that identifies, screens, and manages clean energy projects, enabling project owners an opportunity to exit their portfolios while providing accredited investors—including institutional investors, family offices, and investment funds—unique access to the clean energy investment market.

Be excited and inspired by your fellow co-founders

Having worked with Thomas Byrne and Jon Powers for nearly three years, I’m proud of the company and team we’ve built together at CleanCapital. Their passion and commitment to the clean energy industry remains a driving force for our company.

Thomas Byrne   Jon Powers
Thom and Jon are leading voices in expanding and improving solar industry and they are joined by a talented and inspiring group who I’m sure will continue to drive this industry forward.

Their leadership is an inspiration to our whole team and you don’t have to take my word for it.

I’ve known Jon since his days working in the White House for the Obama administration. His ability to bring synergies to the market, understand and overcome the barriers facing clean energy and sustainability is exceptional. His background in the military and passion for finding solutions to climate change resonate through his work everyday. Thom’s innovative approach and outlook to clean energy finance will help expand the clean energy marketplace as whole and drive more capital to the clean energy technologies that help the economy as well as the climate. This inspiring vision is what pushed me to join the team at CleanCapital and I’ve enjoyed every minute of it.

Zoe Berkery, Vice President, CleanCapital

I’ve known Thom for over a decade and continue to admire his clear commitment to the advancement of solar energy and his ability to develop innovative solutions to industry challenges. When it comes to executing on the most complicated transactions and leveraging partnerships, there is no one better to lead the charge than Jon.  Working together, Thom and Jon continue to make unparalleled contributions to the clean energy space and I’m honored to work beside them.

Melinda Baglio, Head of Acquisitions and General Counsel, CleanCapital

Believe in your solution

Our company was founded on the idea that investing in clean energy doesn’t have to be so hard. We’ve celebrated major milestones in the development of our proprietary technology platform to streamline the project acquisition and investment process. Last month, we celebrated another milestone: two of our projects were ranked as top performing assets by kWh Analytics in the industry’s first “Asset League Table.”

Addressing the climate crisis requires a significant increase in both public and private capital investments in clean energy. Some estimates are as high as $90 trillion over the next 15 years. The reality is that despite the historic growth clean energy is seeing, investment in the sector remains largely stagnant. By leveraging technology to streamline the entire financing process from facilitating data transfer and diligence from the sellers, to comprehensive and ease of underwriting by our investor partners. This efficient use of technology helps us to close transactions quickly and reduces many of the points of friction inhibiting broader investment in clean energy.

Looking to the future

I’m excited about the work we do at CleanCapital. In the last few months, our team has leveraged our new partnership with CarVal Investors to acquire new assets and bring our total to nearly $150 mil in operating solar assets. Through our proprietary platform and capital partnerships, the CleanCapital team continues to bring liquidity to a historically capital inefficient clean energy marketplace.