By Andrew Bary
Barron’s, Jul 11, 2022
The U.S. utility industry’s shift from coal and toward renewables likely will be unaffected by a recent Supreme Court ruling limiting the Environmental Protection Agency’s ability to force fossil-fuel plant shutdowns.
Activists have denounced the ruling, arguing that it’s a blow to the battle against global warming. But, writes Morgan Stanley analyst Stephen Byrd, “We see minimal change to utility capex [capital expenditures] or clean energy growth plans.”
The industry already has halved its use of coal—the worst major fuel source from a climate standpoint—in the past decade to 21% of electricity generation. Its use of coal is headed toward zero by 2035. The shift has helped the U.S. to reduce carbon emissions by more than any other country since 2005. Gas produces about half the carbon emissions of coal.
Key challenges for the industry are maintaining grid reliability and holding down electric rates as renewable power grows.
The Supreme Court case involved a challenge to EPA rules from West Virginia, a big coal producer. “West Virginia is an outlier,” says John Bartlett, president of Reaves Asset Management, which runs Reaves Utility Income UTG –0.39% (ticker: UTG), a closed-end fund. “The movement away from coal is strong, even in Kentucky,” another top coal producer.
Favorable economics and pressure from politicians, state utility regulators, and investors have driven the shift. “Utilities are concerned about getting rid of coal too quickly because of the impact on electric prices,” Bartlett says. “Electricity is a political commodity.” Electricity rates already are heading higher because of increased natural-gas prices.
The websites of many major utilities boast about their shift toward renewables and away from coal. Florida Power and Light, owned by NextEra Energy NEE –0.90% (NEE), eliminated coal plants at the end of 2021. American Electric Power AEP –0.67% (AEP), a large Midwestern utility, sees coal falling to 19% of its fuel mix by 2030 from 41% now, with renewables jumping to 53% from 23%.
The Utilities Select Sector SPDRXLU –0.48% exchange-traded fund (XLU) has shown the electric industry’s defensive credentials this year; it’s little changed against a 18% drop in the S&P 500SPX –0.92%. The sector isn’t cheap, trading for about 20 times projected 2022 earnings, a premium to the overall market, but its outlook is the best in decades. Investments in renewable power, transmission lines, and grid improvements should drive mid- to high single-digit annual profit growth industrywide.
One of Bartlett’s favorites is Ameren (AEE), a Missouri and Illinois utility whose shares trade around $88, or 22 times projected 2022 earnings, and which yields 2.5%. Ameren sees 6% to 8% annual EPS growth through 2026—and its dividend could rise at a similar clip.