Calls to rapidly transition the power sector are rising and favorable economics for wind and solar are leading industry toward a more decentralized power system. But a quicker-than-anticipated shift has potential costs utility professionals are worried about — though few see the risk of stranded assets and plant retirements as a top concern for their company, according to a new Utility Dive survey.
Though 45% of utility employees surveyed in Utility Dive's 2020 State of the Electric Utility Survey see the transition's cost — including stranded assets — as a top risk for the sector, only 18% see generation retirements and stranded assets as a top concern and just 14% said stranded assets present a major challenge to a changing fuel mix.
Utilities, particularly vertically integrated utilities, may feel more confident in regulatory structures and new financing mechanisms that will allow them to recover those costs, say some observers and stakeholders. Others warn utilities should be cautious in their long-term investments, particularly if they want to stay on their customers' good side.
"What I saw was the utility executives are not worried about regulators letting them add to the revenue requirement, but they are concerned that the resulting energy burden on consumers may frustrate the speed of transformation," Senior Policy Advisor and former Executive Director of the Pace Law School Energy and Climate Center Karl Rábago told Utility Dive.
"Basically, regulators have written the check, but [utilities] don't know ... if it'll clear the customer bank."
The U.S. spent almost $500 billion from 2008 to 2018 on renewables, according to Statistica, and global investments reached $2.6 trillion in 2019, according to BloombergNEF. Meanwhile, renewables made up about 17% of the U.S. electricity sector, suggesting more investments will be needed, and a lot more generation will need to go offline.
The stranded asset problem
Stranded assets could come from any power facility investment, and the survey doesn't specify what assets utilities may be watching.
Coal and nuclear have quickly become expensive, especially in contrast to improving economics for wind, solar and natural gas. And though nuclear is valued for its carbon-free attributes, coal's failing economics and greenhouse gas-heavy emissions have made it a top candidate for premature retirements.
More utilities are finding that retiring coal early and adding new natural gas and renewables will ultimately be cheaper for customers, even in traditionally coal-dependent states like Indiana. But quickening a plant's lifeline before its costs have been fully recovered can leave utilities in a difficult place with shareholders and other stakeholders.
That dilemma was a big one for Burbank Water and Power, the municipal utility's Assistant General Manager for Power Supply Lincoln Bleveans said during Utility Dive's Wednesday webinar on the survey's results. Specifically, the utility spent time mulling over what to do with its share of a coal-fired plant they and the plant's other owners planned to convert to natural gas and eventually hydrogen.
"Do we essentially strand our participation in the asset early, even though we would still have to pay the debt and the fixed [operations and maintenance] costs and a bunch of other things and take a big impact on rates? Or do we say you know what we've negotiated the end date back to 2025, so two years early, and when we dispatch it we're going to dispatch it inclusive of a cost of carbon, which makes it more expensive so less dispatch?"
Ultimately, the utility went with the latter, but "it's been a process to getting to a good answer or a very good answer instead of a perfect answer," said Bleveans.
Some states have begun to address that dilemma as part of their clean energy plans — New Mexico, Colorado and Montana have all included some measure of securitization in their utilities' coal retirement plans to mitigate that risk, and stakeholders expect more states to do the same in 2020.
"We get approached a lot about buying gas plants in the U.S. — I wouldn't touch one ... In a lot of these [jurisdictions] it's the next coal, and I think it's coming quicker than we think."
President and CEO, Ontario Power Generation
But there are more financing options than securitization, Director of Energy Research at S&P Global Market Intelligence Lillian Federico said at the group's annual power and gas M&A Symposium in New York City Tuesday. Accelerated depreciation and non-bypassable charges are other avenues for cost recovery currently used by utilities for all sorts of generation assets, she said.
Duke Energy has raised the possibility of shorter depreciation periods for its natural gas assets in particular. Natural gas is jumping on the grid as quickly as coal is exiting, raising concerns from some that as states and utilities make aggressive mandates to get all fossil fuels off the grid by mid-century, continuing to build gas plants out into the 2030s will leave the sector in the same situation it's in with coal.
Natural gas's risk
Although financing mechanisms exist, part of the question is whether the sector wants to go through the issues it's facing right now with coal again in the next decade with natural gas.
"All these gas plants could become stranded assets, no matter how many regulatory approvals you secure and your customers see no value proposition, and the financial instruments … really only are about a few basis points of difference between securitized debt and unsecuritized debt," said Rábago.
The Rocky Mountain Institute in September found that 70% of projected gas plant buildouts will be rendered uneconomic by 2035 as low-cost renewable energy + demand response + energy efficiency portfolios begin to undercut those investments.
"We get approached a lot about buying gas plants in the U.S. — I wouldn't touch one in the Northeast [or] Midwest. I wouldn't go near it," Ontario Power Generation President and CEO Ken Hartwick said at the S&P Global conference. "In a lot of these [jurisdictions] it's the next coal, and I think it's coming quicker than we think."
But some are skeptical that a fossil fuel-free grid is imminent, despite growing shareholder and investor concerns that natural gas needs to be edged out next.
"The reality of the electric grid tells me that you're going to need gas plants for quite a while ... And that's why I am bullish for the next 10 to 20 years [on] gas."
President and CEO, Vistra Energy
"There is no scenario we see nationally where renewables are going to replace entrenched" generation, said Jeffrey Holzschuh, Chair of Morgan Stanley's Institutional Securities and Global Power and Utility Group.
"Anyone that thinks New England is going to be 75% renewable in 10 years, I'm happy to take the other side of that bet for as much as you want. There are great benefits to pursuing capital expenditures in those spaces. We're not going to get anywhere without gas as coal slopes down."
Pipelines in particular remain controversial to build out, because of the environmental risks associated with them, but some argue that building out that infrastructure still makes sense for a lower-carbon gas system, where today's natural gas is replaced by biofuels and hydrogen, which would still need a way to be transported.
For utilities, the question may not be financial, but also physical. Though many utilities believe the future of the grid will be more distributed and less centralized, few know exactly what that will look like. And for now, gas investments remain good for the bottom line and combined cycle plants are often physically better for pairing with a renewable-heavy system, because of their flexible capabilities that coal plants lack.
"The reality of the electric grid tells me that you're going to need gas plants for quite a while," Vistra Energy President and CEO Curtis Morgan told Utility Dive. It has lower greenhouse gas emissions than coal, "it is the most flexible and it's the least cost. And that's why I am bullish for the next 10 to 20 years [on] gas."
Though he does recognize the fuel will be phased out eventually, it's a longer-term question that doesn't top his list of concerns.
"The usage of gas is going to go down over time as renewables proliferate. It's going to happen. It's just how this is phased down, and I think that there is more of a 10 to 20-year time horizon. I don't look at it as a tomorrow thing."
Should utilities be more worried?
Despite utilities' self-assurance, there is mounting evidence that gas assets might pose a stronger risk for investors, particularly as the transition seems more inevitable.
"From an investor standpoint … I think they're worried about it," said Morgan. "I don't think that they think it's necessarily going away. But they don't know. Investors look at uncertainty and if they think there's something uncertain they don't want to invest in it."
For one thing, there will be a 30% decline in natural gas demand between now and 2050, according to research from Citi, the bank's Vice Chairman and Head of Global Power Joseph Sauvage said in New York. And the U.S. Energy Information Administration estimates overall power demand is expected to remain largely flat, though some anticipate heavy electrification may up that growth.
Those things combined would reasonably lead to stranded asset risk, especially as utilities continue to invest heavily in the fuel. And there is a concern growing in some states that utilities are over-investing in supplies they won't need in the future, particularly as more localities push for climate action.
"It's certainly a meaningful percentage of real investors on the [Environmental, Social and Governance] side are having a say. So it wouldn't be shocking to suggest that the return requirements for gas infrastructure might be higher than for renewable infrastructure at the same theoretical risk level."
Managing Director and Global Head of Power and Renewables, Bank of America Merrill Lynch
"What if more major cities and counties really do commit to de-carbonization?" said Rábago. "We can have a gas glut."
There is still the generation gap in coal plant retirements, and the unknown of nuclear power, so gas will be a necessary bridge, Managing Director and Global Head of Power and Renewables at Bank of America Merrill Lynch Raymond Wood said. But the growing risk of climate change is ramping up investor pressure to the point that an increasingly significant amount don't want to see fossil fuels be a part of the conversation at all.
Over the past year, investors have seemed to be split on whether buying into the gas value chain is a hit or a miss, Wood said. While some investors love how it looks on paper, others "hate it. They think gas is a four letter word … because it's a fossil fuel."
Though he doesn't have exact numbers, "it's certainly a meaningful percentage of real investors on the [Environmental, Social and Governance] side are having a say. So it wouldn't be shocking to suggest that the return requirements for gas infrastructure might be higher than for renewable infrastructure at the same theoretical risk level."
For additional information from the "State of the Electric Utility" Survey, listen to Utility Dive's webinar.