Ryan Kelley, chief investment officer at fund manager Hennessy Funds, does not like risk. So when major utilities began to announce sales of their unregulated renewable energy assets about midway through the COVID-19 pandemic, he was rather pleased by the news.
“Utilities are that excellent space where they will tell you, here is our plan for the next five years, and they will mainly make those projections,” Kelley said. “Some people call that boring. But at the end of the day, I like boring.”
But if utilities represent, to an investor, stable and predictable returns, renewable energy does not. Solar might be the hot item on the market for large valuations and high earnings potential, but right now, Kelley — and his clients — are looking for safe places to put their money. And they view renewable energy, and solar in particular, with a growing degree of skepticism after several years of project delays and missed earnings projections.
Apparently sensitive to this growing trend among investors, major utility companies began to sell or spin-off their unregulated renewable energy assets — and some fossil generation as well — in 2021, according to Chris DeLucia, a director within the gas, power and climate solutions group at S&P Global Commodity Insights.
Beyond a hope that investors will award utilities that sell off competitive assets with higher valuations in the stock market, DeLucia and other analysts say multiple co-occurring trends have opened a window for spinning off renewable assets in return for handsome profits in a financial environment where raising capital is increasingly difficult. But while investors and even renewable energy developers might like to see more focused business models from utilities, analysts are split on whether this trend represents a long-term shift in business strategy.
Competitive assets for sale
While it’s hard to ignore the sheer size and number of renewable asset sales coming out of electric utilities, these sales are part of a broader market trend affecting the entire energy industry, DeLucia said.
In spite of policy support and rising demand for renewable energy, energy markets are particularly volatile right now, DeLucia said. The renewables sector has seen increased competition from startups and legacy oil and gas companies, supply chain constraints, permitting issues and interconnection delays. And as a capital-intensive industry, it’s particularly vulnerable to rising interest rates, DeLucia said.
“Across the market, the companies that have a lot more focus on a particular business tend to receive better valuations.”
Senior Equity Analyst, Edward Jones
“When you look at the power sector, there is a lot of change happening and a lot of volatility,” he said. “The outlook has become more muddied.”
At the same time, investors are weighing the possibility of a recession and moving their money to safer, more stable outlets, according to Benjamin Baker, managing director for Greenbacker Capital, an asset management firm focused on renewable energy. There’s also a general move among investors toward more focused, simplified business models and away from conglomerates, Edward Jones utilities analyst Michael Doyle said.
“Across the market, the companies that have a lot more focus on a particular business tend to receive better valuations,” Doyle said. “Over time, investors said this [conglomeration] doesn’t make sense. We would rather buy a more focused business” with a clear strategy for growth.
This dynamic could explain why recent utility spin-offs haven’t been limited to renewable energy assets. In May, NextEra Energy Partners announced plans to sell its natural gas pipelines in order to become a 100% renewable energy company, with CEO John Ketchum saying the move was inspired in part by investors who had indicated they would put more money into a “pure play” company. Dominion Energy has also sold some of its competitive gas assets, citing a similar strategy of simplifying its business.
But NextEra, DeLucia said, is an outlier, as the bulk of the companies looking to streamline and sell are unloading competitive renewable energy portfolios — including some that recently acquired those assets. Con Edison, which acquired renewable energy assets from Sempra in 2018, turned around and sold them to RWE in 2022 for $6.8 billion. AEP followed a similar pattern, buying renewable energy projects from Sempra in 2019 and selling for $1.5 billion earlier this year.
Duke Energy became the latest company to sell its commercial renewable portfolio when it reached a $2.8 billion deal with Brookfield Renewable in June.
Although he did not name specific companies, NextEra’s Ketchum criticized the utilities putting renewable portfolios up for sale and warned investors not to use these sales as a means of evaluating the value of NextEra’s assets during an earnings call on July 25.
“Those are not what I would characterize as high quality renewable energy assets,” he said. “We’ve worked hard to get quality assets. I like to believe, and we’re not perfect, but we don’t make some of the same mistakes that you see the other developers make. We are much better positioned.”
But the sales seem likely to continue, said Jeremy Klingel, a senior partner covering energy and utilities at digital services firm West Monroe. Utility companies with smaller to mid-sized renewable energy portfolios seem especially likely to sell, he said. These companies have always seen renewable energy as something “interesting and tangential,” something that they could be easily persuaded to sell if the right deal came along, he added.
“We are seeing solar farms and battery storage projects go for valuations that are much higher than we ever thought they could.”
Managing Director, Greenbacker Capital
Some bigger portfolios are still expected to hit the market in the near future as well. And that, analysts say, is simply because now is a good time to sell.
In spite of market volatility, demand for renewable energy continues to boom, propelled by private and government interest in decarbonization. That demand has exceeded the grid's current capacity for new projects, and where there is an imbalance between supply and demand, prices tend to rise. That, Baker said, is what has transpired in the renewable energy sector.
“We are seeing solar farms and battery storage projects go for valuations that are much higher than we ever thought they could,” Baker said. “Even in light of inflation and [higher] interest rates and things that mathematically should cause the value of assets to go down, there has been such a fervor for this type of investment, that asset prices are not going down.”
At the same time, the price of raising capital has increased. So if a utility has a need for financing, and “if they can sell a solar farm for $5 million, that’s way cheaper than to take money from someone like us,” Baker said.
And utilities do have a need for financing, Klingel said — especially some of those that have sold large renewable energy portfolios recently like Con Edison. U.S. demand for electricity has accelerated in recent years thanks not only to economic growth, but also the growing popularity of electric vehicles and emerging trends toward building electrification.
“Regulated utilities tend to have a mindset that is pretty conservative, and there is a huge need in the energy transition for a focus on transmission — an area where you need to have a conservative and patient mindset.”
Vice President, Asset Marketplace, LevelTen
The grid, Klingel said, is unprepared for this growth, so many utilities have found themselves in a position where they need to make massive investments in transmission and distribution. Given the lending environment, the timing of these transmission shortfalls could perhaps be better. But as Klingel sees it, this isn’t a terrible outcome for utilities.
“You’re getting a return off the assets that you developed on the renewable side, you’re walking away with a potentially significant upside depending on how those deals work, you get to focus on your core business which will be more lucrative in the near-term because of additional infrastructure funding, and you get to reduce your risk associated with the deregulated side,” Klingel said.
These prospects are particularly tantalizing to investors like Kelley, who previously saw a similar trend in the natural gas sector in 2011. At the time, Kelley said, natural gas utilities faced something of a reckoning after a series of fatal pipeline explosions led to criticism that the distribution system’s old, cast iron pipes were unreliable. That prompted the federal Pipeline Safety, Regulatory Certainty, and Job Creation Act of 2011, which created regulatory programs to improve the safety of the nation’s natural gas pipelines.
Over the past 12 years, regulators and utilities have invested billions in pipeline modernization. And the great thing about these safety measures, Kelley said, is that the replacement and maintenance of the pipes are capital expenditures that get added to the rate base, which means customers pay for the upgrades while the utility’s earnings per share and dividend growth accelerate, driving increased returns for investors.
“So I think this is basically history repeating itself, but on another side of the utility business,” Kelley said. “We saw it with natural gas, and now we’re going to see it ... with the electric grid.”
Development or distribution
Patrick Worrall, vice president of the asset marketplace at LevelTen, believes a more focused utility sector with fewer competitive assets could be good for renewable energy developers as well. Interconnection backlogs driven in no small part by a lack of transmission remain one of the biggest problems plaguing renewable energy developers, and while a few private companies have tried to address this themselves, utilities just seem better at transmission development than private developers, Worrall said.
“Regulated utilities tend to have a mindset that is pretty conservative, and there is a huge need in the energy transition for a focus on transmission — an area where you need to have a conservative and patient mindset,” Worrall said. For utilities to focus on transmission and renewable energy developers to focus on building renewable energy should be a boon to all, he said.
That benefit should extend to investors as well, Baker said, given the scale of the renewable energy portfolios changing hands. Utilities may not be full-time renewable energy developers, but some hold assets that rival those of the largest development platforms. NextEra, Worrall said, probably owns the largest renewable energy platform in the U.S. — though nobody expects NextEra to sell it any time soon. Companies that have sold renewable portfolios have in some cases earned more than $5 billion — a considerably larger sum than most existing portfolios are worth. After the top 10-15 renewable energy developers, Worrall said, “you very quickly get to much smaller [portfolios], a couple billion or less.”
“Every business cycle is just long enough for a whole new group of people to examine a business model and say, well, they all failed, but I could do this better.”
Managing Director, Greenbacker Capital
To sell an asset of that size and value, you need to find a buyer who has enough capital to pay. And in the case of these utilities, Baker said, that’s increasingly limited to other large utilities, large-scale developers with comparable portfolios, and investors interested in holding large portfolios — the Blackstones of the world. Indeed, AEP’s 2023 portfolio sale went to Blackstone Infrastructure, a pension fund, and developer Invernergy. Con Edison sold to another utility, RWE. Duke sold to one of the nation’s largest renewable energy developers.
But as investors and developers consolidate these assets into ever-larger portfolios, Baker said, they’ll eventually run out of potential buyers — there simply won’t be anyone large enough left to pay for them. That will leave the owners of these assets, whoever they ultimately are, with two remaining options: hold, or go public. And no one in the investment community is complaining about the possibility of renewable energy IPOs.
“There is a dearth of publicly traded, pure play renewables in the market, and I think people would be excited to see those,” Worrall said.
New paradigm or business as usual?
Generally speaking, investors who watch the renewable energy space don’t believe we’ve seen the end of renewable energy spin-offs from regulated utilities. Several interviewed for this story indicated they had information suggesting additional large sales are in the works, though the utilities named did not respond to requests for comment on this story.
Even so, the window of greatest opportunity may be closing, said Doyle, who pointed to the fact that the Duke renewables sale took longer than initially expected. Much like the housing market, high valuations in the renewable energy sector were driven at least partly by the low interest rate environment that followed the onset of COVID-19, he said. Higher interest rates have eroded the value of renewable energy portfolios and caused market demand to cool.
So was this whole era of utility-owned competitive renewable energy a flash in the pan, or has it set the stage for a new business cycle where utilities develop competitive assets that they can sell opportunistically to raise capital? Analysts’ opinions are mixed.
Klingel believes many utilities may jump back in to deregulated energy development if the market conditions are right — and the timeline for the shift back to development could be relatively short, given the number of new opportunities created by the Inflation Reduction Act. Energy storage and solar panel manufacturing are interesting opportunities getting a lot of attention in the press, but the real “dark horse” on the horizon, Klingel said, is hydrogen.
“Given the complexity of the infrastructure required to support [hydrogen], it would not surprise me if utilities and utility holding companies continue to see that as their future business,” he said.
Crystal balls are always cloudy, Klingel said, but if the interconnection situation turns around he wouldn’t be surprised to see utilities jumping back into competitive energy development in the next 12-24 months.
Baker is less certain. It seems likely, he said, that utilities could find success going either direction — either getting back into competitive energy development after selling for a profit, or sticking exclusively with regulated assets. But investors, Baker said, do prefer a business model that is simple and easy to understand, and it might be better for everyone if utilities stayed focused on transmission and distribution.
“The one thing I would bet on is humans being in a constant loop of repeating the things that they did in the past in a slightly different way,” he said. “Every business cycle is just long enough for a whole new group of people to examine a business model and say, well, they all failed, but I could do this better.”