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Why The Clean Electricity Payment Program Would Benefit Coal-Heavy Utility Stocks

Posted to Energy Innovation: Policy and Technology LLC in the The Energy Collective Group
Mike O'Boyle's picture
Director of Electricity Policy Energy Innovation: Policy and Technology LLC

Mike is Energy Innovation’s Director of Electricity Policy. He directs the firm’s Power Sector Transformation program to uncover policy solutions for a clean, reliable, and affordable U.S....

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  • Aug 16, 2021 3:51 pm GMT
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As part of the budget reconciliation process, Congress is currently considering a Clean Electricity Payment Program (CEPP) that would provide customer rebates to utilities that supply a greater share of clean electricity every year. This CEPP sets a target of 80 percent clean electricity by 2030, on the way to achieving President Biden’s goal of 100 percent clean electricity by 2035. Rather than imposing a standard or mandate, the policy offers utilities cash incentives to buy down the cost of the clean energy transition.

But electric utility reactions to ambitious federal clean energy goals have so far been mixed. Some have balked at the timelines implied by President Biden’s 100 percent clean electricity goal, while others have embraced a strong interim goal of 80 percent emissions reductions by 2030.

But what explains this split? Utilities like Exelon or PSEG heavy on nuclear and renewables were first to publicly support such a plan. Conventional wisdom suggests they have the most to gain, or least to lose from federal clean energy policy. But conventional wisdom is wrong.

New analysis from Morgan Stanley indicates it’s coal-heavy utilities and their shareholders who have everything to gain from a federal program to support 80 percent clean power. Utility managers, as fiduciaries to their shareholders (and beneficiaries of lucrative stock options), would be wise to support a federal clean electricity payment plan that incentivizes greater shares of clean electricity at lower cost, if it means higher returns.

Monopoly – it’s not just a board game

To understand why Morgan Stanley reached this conclusion, let’s take a step back and examine how monopoly utilities make and grow their profits, and by translation, support continued stock price growth.

Simply put, utilities recover the actual costs incurred to serve customers through electricity prices set by regulators. These prices include fixed profit margins for company shareholders earned on infrastructure investments like poles, wires, power plants, substations, and even the smart meter in your house. These returns make investors eager to put up capital for these investments, so that utilities can build what they need to build.

In short, investing in new capital is good for business, so long as regulators are on board.

Morgan Stanley’s Analysis

This relationship underpins a recent Morgan Stanley Power & Utilities Equity Research team analysis of 74 utility stocks, in which analysts describe the immense opportunity for growth presented by a rapid transition from coal to clean. When it comes to monopoly utilities, choosing wise investment opportunities means seeing around the corner to determine which ones are well-positioned to have approved capital investments.

According to Stephen Byrd, Head of North American Equity Research, Power/Utilities for Morgan Stanley and lead author of the report, many electric utilities “have an opportunity to achieve a triple benefit from shutting down coal-fired power plants and building renewables: faster earnings growth, lack of upward pressure on customer bills from this shift, and lower carbon dioxide emissions.”

Morgan Stanley’s analysis scored 74 utilities focusing on four factors:    

1. near-term growth projections (measured by capital investment growth),

2. capital investment opportunities from coal shutdowns

3. cost performance, and

4. state-level regulatory environment

The analysis found that coal-heavy utilities like PPL and First Energy currently trading at a discount to peers have major potential to grow their stock prices by embracing the renewable energy transition. Byrd noted via email that this is a “large and growing opportunity for utilities, driven by the rapid cost reductions for solar, wind, and energy storage.”

The reason? Renewables are capital-intensive investments. By contrast, old coal assets have mostly depreciated, meaning monopoly utilities can earn high returns by putting new steel in the ground.

May 2021 analysis from Morgan Stanley. Numbers in parentheses by company ticker is the premium or (discount) the utility stock trades to its peers.

Consider the case of American Electric Power (AEP), whose assets in Kentucky, Ohio, and West Virginia span Appalachian coal country. Once the largest U.S. coal utility, AEP recently announced a plan to reduce its carbon emissions 80% below 2005 levels by 2030 (in line with Biden's 2035 goal). AEP is not projecting major rate increases will be necessary to meet these goals.

Source: Company data, SNL Financial, Morgan Stanley Research estimates.

This is laudable, but far from altruistic. AEP intends to invest in 16,600 megawatts (MW) of renewable energy projects by 2030 and retire 8,000 MW of fossil resources. Morgan Stanley estimates the opportunity to invest in renewables to replace existing coal is $13.8 billion. To raise the capital needed, AEP plans to sell Kentucky Power, a coal-intensive subsidiary struggling to achieve consistent returns. That shift translates into consistent earnings growth while reducing the risks of continuing to operate uneconomic coal.

What does this have to do with Congress's Budget Plan?

So what does this have to do with Congress’s budget proposal? The Senate proposal includes a clean electricity payment program, that would pay utilities to rapidly and consistently invest in new renewables and reduce fossil generation and achieve the goals of an 80 percent by 2030 clean electricity standard. According to University of California, Berkeley and Energy Innovation analysis, this would require $1.5 trillion in new investment in wind, solar, and storage by 2030 with virtually every electric utility sharing a piece of this pie.

New Capacity Additions in the 80% Clean Case by 2030.

Morgan Stanley has identified a major opportunity to increase stock prices through more rapid grid decarbonization and grow investor earnings. A national clean electricity payment program would make this happen, providing a boon for struggling coal-heavy utilities who can successfully execute on this strategy, much like AEP hopes to do.

All this is to say – what are regulated utilities waiting for? With a budget reconciliation bill hanging in the balance, investor-owned electric utilities would be wise to jump into the game.

 

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Thank Mike for the Post!
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Matt Chester's picture
Matt Chester on Aug 16, 2021

Morgan Stanley has identified a major opportunity to increase stock prices through more rapid grid decarbonization and grow investor earnings. A national clean electricity payment program would make this happen, providing a boon for struggling coal-heavy utilities who can successfully execute on this strategy, much like AEP hopes to do.

Such great insight-- in a perfect world, decarbonization would be done for the reason that it's the right thing to do, but to actually make things happen we need to highlight the financial benefits of doing so and thus the costly proposition that inaction will cause. 

Bob Meinetz's picture
Bob Meinetz on Aug 16, 2021

"According to Stephen Byrd, Head of North American Equity Research, Power/Utilities for Morgan Stanley and lead author of the report, many electric utilities 'have an opportunity to achieve a triple benefit from shutting down coal-fired power plants and building renewables: faster earnings growth, lack of upward pressure on customer bills from this shift, and lower carbon dioxide emissions.'"

Not exactly. To rephrase:

"Many electric utilities have an opportunity to achieve a double benefit from replacing coal-fired and nuclear power plants with new gas plants, and building a few token solar/wind farms: faster earnings growth and the perception of being "environmentally responsible". But it comes at expense of increased upward pressure on customer bills, increased carbon emissions, and long-term dependence on natural gas."

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