TOPIC #1
Utility Themes
Headwinds and tailwinds characterize the utility sector as the clean energy transition continues.
Utility Cost Pressures Continue to Mount, But One Area of Relief
Since 2020, many costs in both the U.S. and global economies have increased. Costs for utility materials and services are no exception.
Figure 1.1 shows the increase in certain utility-related commodity and labor costs. The figure shows that since early 2014, utility labor (weekly earnings of all utility employees) has increased more than 40%, while electric transformers have increased 80%.
- Supply chain bottlenecks have been cited as an ongoing issue for large utility equipment.
- While weekly utility employee wages have grown, overall employee headcount has only increased by about 7% during that same period.
Offsetting some of these increasing costs has been the declining cost of natural gas (see Figure 1.2). Natural gas-fired generation continues to serve as the marginal (price-setting) generation cost and the largest fuel source for electricity generation across much of the United States.
- Average U.S. wholesale power prices for 2024 are expected to range between $30 and $50 per MWh (outside of the Northwest and New England), driven by expected low gas prices.
- As recently as February and March 2024, natural gas prices had settled below $2 per MMBtu. Of course, weather, geopolitical, and other dislocations may affect these subdued prices.
Figure 1.1: Selected Material and Labor Costs (Jan. 2014–Feb. 2024) (Index: Jan. 1, 2014 = 100)
Note: Monthly data.
Source: Federal Reserve Economic Data: Producer Price Indexes, Federal Reserve Bank of St. Louis (accessed Mar. 29, 2024)
Figure 1.2: Henry Hub Spot Natural Gas Prices (Index: Jan. 2, 2014 = 100)
Source: Federal Reserve Economic Data: Producer Price Indexes, Federal Reserve Bank of St. Louis (accessed Mar. 29, 2024).
KEY TAKEAWAYS
Increasing demand, incentives, a changing portfolio of resources, and grid investment are driving significant capex for energy utilities.
Weighing against that are elevated and/or growing costs and capital needs.
Utilities are navigating the capital markets and rate proceedings to ensure sufficient financial resources to satisfy those investment requirements.
Increasing demand, incentives, a changing portfolio of resources, and grid investment are driving significant capex for energy utilities.
Weighing against that are elevated and/or growing costs and capital needs.
Utilities are navigating the capital markets and rate proceedings to ensure sufficient financial resources to satisfy those investment requirements.
Capital Expenditures Make Their Way to the Sector
Capital expenditures continue to trend upward for both the gas and power sectors (Figures 1.3 and 1.4). Increasing projected capex is a function of several macro phenomena, including:
- Economic and related load growth in many territories
- Clean energy transition investments
- Cost inflation, creating a need to re-assess required project capex
Figure 1.3: Electric Investor-Owned Utility Capital Expenditures (2016–2025 Projected) ($ Billions)
Notes: *Projection as of Sept. 2022. **Projection as of Sept. 2023. 2022 estimates by type based upon Sept. 2022 forecast allocations applied to actual total for 2022.
Sources: EEI Finance Department; company reports; S&P Global Market Intelligence (updated Sept. 2023)
Figure 1.4: Energy Utility Capex by Business Category (2023–2025 Forecast)
Source: Regulatory Research Associates, a group within S&P Global Commodity Insights
A growing amount of investment is for adaptation, hardening, and resilience (AHR), particularly in the transmission and distribution sectors. Figure 1.5 shows survey results that indicate that investor-owned utilities attribute 30% of transmission capex and 40% of distribution capex to AHR.
Generation capacity investment continues to grow, including significant renewables development, to meet policy- and utility-driven targets for decarbonization.
Finally, the Infrastructure Investment and Jobs Act and the Inflation Reduction Act have spurred activity in both generation and grid development. Many programs remain to be funded and implemented.
Figure 1.5: Adaptation, Hardening, and Resilience (AHR) as a Driver of Future Electric T&D Investment
Note: Totals may not equal sum of parts due to independent rounding.
Source: EEI Financial Analysis and Business Analytics, EEI member company survey (2023)
Upward Pressure on Rates to Keep Up with Increased Spending
With increasing capex spend and other operating cost pressures, gas and electric utilities are actively pursuing rate cases in many jurisdictions. State public utility commissions issued more than 160 decisions in 2023 (see Figures 1.6 and 1.7).
This high level of activity continues into 2024. As of March 12, there were 55 electric and 52 gas rate cases pending across 38 states and the District of Columbia. The rate increases sought aggregate to $16.5 billion in net increases, excluding later years of multiyear rate requests.
Allowed returns on equity (ROE) have been steadily declining over the past 20+ years in tandem (but at a slightly slower pace) with a historic cycle of ever-declining interest rates. These interest rates have risen significantly since 2020, without a commensurate increase in average ROEs while also raising debt costs.
Figure 1.6: Average Gas and Electric Authorized Returns on Equity, Treasury Yields and Spreads, and Rate Cases Decided (2004–2023)
Source: Regulatory Research Associates, a group within S&P Global Commodity Insights
Figure 1.7: Electric and Gas Rate Change Amounts from Decided Rate Cases (in $ Millions) (2004–2023)
Source: Regulatory Research Associates, a group within S&P Global Commodity Insights
Regulators Hesitate and Rating Agencies Monitor
Concerned about customer bill impacts and affordability, some PUCs are resisting the level of rate recovery sought by both power and gas utilities, rejecting or substantially reducing proposed rate increases. In November 2023, for example, PUCs in California and Wisconsin pared back requested utility rate increases citing affordability.
While utilities continue to require capex to fund infrastructure expansion as PUCs challenge revenue requirements, credit rating agencies are monitoring utility balance sheets, free cash flow, and credit metrics. S&P Ratings has pointed to a negative outlook for North American regulated utilities, citing various concerns:
- Rising physical risks (i.e., wildfires) and high cash flow deficits that may not be sufficiently funded in a “credit-supportive manner”
- Limited financial cushion to support “unexpected events” such as higher interest rates (particularly with near-term debt maturities), changes to inflation, delays to offshore wind projects, and rising taxes
Moody’s and Fitch Ratings are more sanguine, pointing to “remarkably steady” free cash flow metrics and positive factors such as demand growth and IRA funding.
Dividends have long been a key attraction for utility investors. With expected higher equity needs and financing costs, some utilities may consider lowering payout ratios.
- To date, dividend growth remains strong. Most electric utilities have a target payout ratio of 60% or greater, with the sector’s dividend yield averaging 3.8%.
- A development to monitor will be whether lower dividend growth (“invest to grow”) will be needed over the next several years. Much depends upon earnings growth as well.
Source: lucky-photo - stock.adobe.com
Tailwinds for the Electric Sector
A common theme across the sector is growing power demand, with sometimes significant anticipated near-term load increases.
EEI estimates 4.7% annual growth in net energy over the next five years for North America (compared to estimated 2.6% annual growth as recently as 2022), with an additional 38 GWs in peak demand growth over that period.
Growth is being driven by several factors:
- Data centers and effects of artificial intelligence, with increased computational requirements and 24/7/365 operations leading to increased energy requirements
- Electrification of end-uses, including heating and transportation
- Expansion of manufacturing, including reshoring of industrial production
Figure 1.8 summarizes selected themes from a sample of companies across various types of energy utilities.
For some utilities, federal incentives in the IIJA and IRA and supportive state policy provide momentum for investment in grid improvements, carbon-free generation, vehicle electrification, and new technologies such as hydrogen.
- Figure 1.9 illustrates how different utilities are pursuing different low-emitting resource technologies.
- Among new generation options, solar has leapfrogged other technologies in anticipated capacity build over the next two years (see Figure 1.10).
Figure 1.9: Examples of Different Electric Utilities Placing Different Bets on Technology
Source: Company reports; ScottMadden research
Figure 1.10: Annual U.S. Capacity Additions and Retirements by Fuel Type (2014–2025 Projected) (GWs)
Solar comprises an overwhelming proportion of new power generation capacity being brought online.
Note: De minimis additions and retirements are charted but are not included in the legend.
Sources: EIA; ScottMadden analysis
IMPLICATIONS
After years of flat electricity demand, utilities must now deal with the enviable problem of significant and potentially rapid load growth. In tandem, they must consider transition and decarbonization goals, resilience and modernization requirements, and, ultimately, customer affordability.
Utilities are considering the nature, level, and timing of infrastructure investment to accommodate demand growth and other priorities. Integrated planning can help optimize those investments.
In addition, utilities must also engage customers, regulators, and other stakeholders to reduce resistance to appropriate cost recovery and capital funding needs. Part of this engagement may include consideration of programs to address affordability and energy burden, particularly for economically vulnerable customers.
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