From The Economist - July 27th 2019
Can the monopolists at the heart of America's shift to cleaner energy thrive in a new climate?
It is hard to ignore the wind hurtling across the green expanse of southern Minnesota. On highways, gusts nudge cars. Corn stalks shimmy in the breeze. And towering overhead, white turbines twirl, XCEL Energy bought its first wind farm in the state in 2008. The utility's turbines now stretch to the horizon—its ambitions, far beyond. This month XCEL, still dependent on coal to generate electricity, proposed big investments in solar and wind power in the upper Midwest, part of its bid to produce carbon-free electricity in the eight states it serves by 2050. It is one of many firms making multi-billion-dollar gambles on the shift to cleaner energy.
The opportunity is vast
Last year America's power sector generated 4.2bn kilowatt-hours of electricity and 1.8bn tonnes of carbon dioxide (a third of America's total). Only 17% of power generation is currently from renewable sources, and another 19% from nuclear energy. If the $400bn industry were a country, it would be the world's fourth-biggest emitter, ranking between India and Russia. Some see benefits in moving slowly to cleaner sources of power. Duke Energy, America's biggest utility, this month proposed large investments in natural gas in Indiana and will keep a giant coal plant there open for another 20 years, XCEL is among those that sniff profits in the winds of change.
For decades, to describe electric utilities as dull was not an insult but a summary of corporate purpose: keep lights on, rates low and returns steady. The somnolence of their corporate offices, a seasoned visitor quipped, was disturbed only by the periodic whirr of a printer. A push in the 1990s to break up the power monopolies that still dominate America's electricity market lost steam after blackouts in California in 2000-01 curbed enthusiasm for deregulation. It suspended retail choice for consumers soon after. Today just 15 states have competitive retail electricity markets.
The business model of utilities seems designed not to speed up innovation but to stifle it. Some firms corner the market for transmission. Vertically integrated monopolists generate power, too. To keep them in check, a utility commission reviews a regulated utility's investments, then sets rates that cover costs, plus an annual return on invested capital of about 10%, net of depreciation.
This soporific status quo has served utilities rather well. In recent years regulators have authorized big investments in transmission and distribution, and profits from these have helped to support utilities' dividends and share prices.
Now things are heating up
Some companies must contend with the impact of global warming. Pacific Gas and Electric, California's largest power company, is battling regulators, politicians and investors over its alleged role in causing devastating wildfires during recent droughts. Other companies are trying to make their infrastructure more resilient to floods along coasts, tornadoes in the Midwest and other climatic disruptions.
The politics of green electricity, too, are evolving. Clean-power plans feature prominently in the Democratic presidential primaries. States led by Democrats, and even some led by Republicans, have set goals for clean electricity; in all, 29 have set targets for raising its share. Utilities face scrutiny from green-minded asset managers. In February institutional investors with $1.8trn under management urged them to adopt targets for carbon-free electricity. Credit Suisse, a bank, estimates that utilities need to spend over $100bn by 2030 to meet states' renewables goals.
Most important the economics of power is being turned on its head by the falling costs of renewables. The "levelised" cost of electricity—which includes capital and operating spending to generate it over a plant's lifetime—is now lower for wind or solar power than it is for coal. Coal's share of power generation has sunk from about half in 2005 to 27% in 2018. It will fall further, despite President Donald Trump's plan, announced in June, to loosen regulation of coal plants.
The big question for utilities is how much of coal's declining share to replace with natural gas, and how much with renewables. The answer depends partly on their location. The high cost of shipping natural gas and oil to Hawaii is one reason why that state has particularly bold goals for renewables. On July 10th Hawaiian Electric filed an ambitious proposal to solicit bids for new wind and solar power. Some of the states where XCEL serves customers are blue and others red, but all are among America's gustiest. That made it easier for Ben Fowke, its chief executive, to espouse a renewables strategy. That it appeals to climate-friendly investors is "icing on the cake", he says.
Regulated utilities make money by investing capital; the variable costs of fuel are borne by consumers. But wind has the benefit of being free, no matter how hard it blows. So XCEL settled on a strategy to please both investors and customers: invest more in wind farms, on which it can earn a regulated return, and spend less on fossil fuels, on which it cannot. In the long term, consumers save money and utilities make more of it.
Shareholders have welcomed this "steel for fuel" strategy, as Mr Fowke calls it. Last year XCEL’s earnings per share grew by almost 10%. Utilities such as CMS, in Michigan, are following its lead.
For others, accelerating the move away from fossil fuels holds less allure, and not simply because they operate in places with less wind or sun. Securing land for wind farms in America's densely populated north-east is costlier than in the Midwest. Retiring an ageing coal plant is one thing, points out Michael O'Boyle of Energy Innovation, a research group; scrapping a newer or newly refurbished one is another. Some states continue to prop up coal. Ohio's senate passed a bill this month to subsidize coal plants in which Duke holds stakes.
Natural gas complicates the picture further. Most investors reckon that some gas is necessary to balance the intermittent power of the wind and sun—at least until storage becomes cheaper and more efficient. The question is, how much?
The availability of cheap gas has dissuaded many utilities in the region that sits atop the shale-rich Marcellus formation in America's east from investing much in re-newables, says Michael Weinstein of Credit Suisse. Renewables struggle to compete in Florida, too, where newish, efficient gas plants owned by a subsidiary of NextEra, a giant power company, offer cheap electricity. The Energy and Policy Institute, a pro-renewables think-tank, recently analyzed America's 22 dirtiest investor-owned utilities. It found that about half, including Duke, Dominion and American Electric Power, plan to decarbonize more slowly in the coming decades than they did from 2005 to 2017 mainly because of investments in gas plants. In proposals for new investments in Indiana and the Carolinas, Duke argues that natural gas is needed to keep prices low and power reliable.
Despite XCEL’s clean-power plans, which include nuclear energy on top of renewables, even Mr Fowkes says that eschewing gas altogether would be "a little shortsighted". His firm's plan for the upper Midwest is for gas to generate a quarter of electricity by the mid-2030s.
But big investments in gas—such as Duke's plan for it to account for two-thirds of the Carolinas' new generating capacity carry risks. The first is that some gas plants, like coal ones before them, become uneconomic as renewables keep getting cheaper. In April, Indiana's utility commission rejected a proposal for a gas plant by Vectren, another utility, for just that reason. If America one day sets a price on carbon emissions, customers could be left paying for utilities' bad bets on fossil fuels.
The second risk is that if utilities do not offer enough clean power, customers may get it elsewhere. Homeowners are installing solar panels on their roofs. Big corporate buyers of electricity, including Google and General Motors, this year launched a campaign to ensure an affordable supply of clean power. Such challenges make life for utilities less boring. Tackling them head on could make it more lucrative. ■