3 Utilities to Watch During the Clean Energy Transition

Utilities will play multiple roles in the clean energy transition, including direct investment in renewable energy or supporting infrastructure. Nearly all U.S. utilities have clean energy or emissions-reduction goals that drive their growth investment plans.

Here's a look at three of these companies that should benefit from this transition.

American Electric Power AEP

Morningstar Rating: ★★★ Morningstar Economic Moat Rating: Narrow Fair Value Estimate (as of Sept. 20, 2021): $89

What are the company's clean energy plans? American Electric Power, or AEP, is proposing to build up to 16.6 gigawatts of new renewable energy across its system through 2030, doubling its previous goal.

Though still heavily concentrated in coal generation, AEP has large renewable energy investment plans: It expects to install 16.5 GW of renewable energy through 2030, with 10.6 GW of new wind generation across its wind-rich resource service territories and 5.9 GW of new solar generation while retiring nearly 5.0 GW of coal generation.

Last year, AEP increased its carbon emission reduction goal to 80% by 2030, up from its previous 70% target, and the company plans to achieve net-zero emissions by 2050 based on 2000 emission levels.

Because many of its subsidiaries operate in states such as Texas, Oklahoma, and Arkansas, which have strong wind resources, wind will represent more than 60% of AEP's renewable energy plans.

What kinds of changes does the company need to make? AEP faces a higher risk of stranded assets because of its high concentration of coal generation. Its long-standing association with some of the largest coal-producing states has slowed the company's transition away from coal.

Though AEP has plans to transition away, it might not be fast enough: Several of its large coal plants have planned retirement dates well past 2030. AEP will need to work closely with policymakers in states where we view regulatory constructiveness as average to ensure that any early retirements of coal plants don't come at the expense of shareholders.

Why do we see potential? We expect the hesitance against the adoption of renewables to change. State regulators overseeing AEP's service territories are now embracing renewable energy development, providing significant growth opportunities.

We don't think investors appreciate that AEP's predominant business is transmission and distribution and is one of the largest transmission and distribution owners in the nation. This unit is well positioned to benefit from needed infrastructure to support the planned renewable build-out. Additional investment opportunities rest in asset replacement, local reliability, and regional transmission operator projects.

NextEra Energy NEE

Morningstar Rating: ★★ Morningstar Economic Moat Rating: Narrow Fair Value Estimate (as of Sept. 20, 2021): $78

What are the company's clean energy plans? NextEra's management plans to install 23 to 30 gigawatts of renewable energy from 2021-24 at its Energy Resources subsidiary, more than double its current renewable energy portfolio.

Though NextEra was an early adopter of wind generation, the company is now shifting its focus to solar. Nearly half of planned renewable energy growth at Energy Resources through 2024 will be solar, with the remaining a mix of wind and energy storage.

NextEra will also benefit from solar investments within its regulated-rate framework in Florida. It plans to install nearly 20 GW of solar with 1.2 GW of energy storage by 2030, bringing solar's market share in the state to 20%.

That said, NextEra will continue to develop its vast wind portfolio at Energy Resources. The company will continue to benefit from the competitive advantage it has built in the area, planning to add 6 to 8 GW of wind through 2024, with up to another 1.4 GW of repowering opportunities.

How is the company advantaged by its regulatory environment? Florida provides an excellent regulatory framework for utilities. NextEra subsidiary Florida Power & Light has proved adept at operating within this framework while providing customers with the lowest electricity bills in the state.

Additionally, regulators wisely waited for economic conditions to improve before incentivizing the states' investor-owned utilities to develop solar generation. Now, with improving solar economics, Florida regulators' highly constructive rate-setting mechanisms are encouraging solar development. Investors will earn an immediate return on renewable investments under automatic customer rate adjustments.

Why do we see potential? No utility in the United States is better positioned to benefit from the renewable energy transition and the Biden administration's clean energy focus than NextEra. Its history of best-in-class execution gives us confidence that it can retain its position as the leading clean energy owner and developer in the country.

Edison International EIX

Morningstar Rating: ★★★★ Morningstar Economic Moat Rating: Narrow Fair Value Estimate (as of Sept. 20, 2021): $70

What are the company's clean energy plans? Edison International, which serves 15 million residents in Southern California, excluding Los Angeles, will have to make distribution investments to transition the grid from uniform standards to be more modular and flexible to accommodate electric vehicles, solar, and energy storage.

Statewide, Edison estimates $75 billion of grid investment by 2045, of which about $25 billion would be distribution and related local area energy grid investments. Edison alone plans to spend more than $5 billion annually in 2021-24 on its distribution system for maintenance, upgrades, wildfire safety, electric vehicles, and demand growth.

How is the company advantaged by its regulatory environment? While PG&E received much of the regulatory and political pushback from recent fires across the region, California has proved to be a strong partner with Edison International. At its core, we think California is a highly constructive regulatory environment. Regulators recognize the important role that utilities play in achieving the state's environmental and energy policies. Edison's infrastructure investments to support these policies result in limited pushback from regulators, helping support earned returns on capital.

We forecast 6% annual earnings growth based on Edison's current investment plan. This growth trajectory could be lumpy, but regulators have approved much of Edison's $5 billion annual investment plans in 2021-23 based on its general rate-case proposal and other programs. We think state policies--including California's 100% renewable energy by 2045 target--give Edison a good case to gain continued regulatory support for its investment plan.

Does the company face any risks? Operating cost discipline will be critical to avoid large customer bill increases related to its investment plan. Edison will probably face more regulatory scrutiny to prove its investments are producing customer benefits. One threat to its growth is a cut in its industry-leading allowed returns on equity.

Why do we see potential? Edison's Southern California territory will be the epicenter of the transition to clean energy and a more electrified economy. Investments in grid upgrades, electric vehicles, batteries, reliability, safety, and more will support a decade of growth.