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Utilities face tough choices in meeting climate goals after natural-gas binge

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Some investors worry that natural gas plants such as the Scattergood plant in Los Angeles will be the next class of assets stranded as the cost for cleaner alternatives continues to fall and utilities pursue new climate targets.
Source: AP Photo

Environmentalists and consumer advocates for years have complained that utility companies are piling up risks by continuing to invest in natural-gas infrastructure even as the costs of cleaner alternatives fall and scientists warn about the threats posed by climate change. With the recent explosion in sustainable investing, utilities are under even more pressure to slash greenhouse gas emissions, and some may well face "a lot of stranded-asset exposure" said Jim Hempstead, a managing director of global project and infrastructure finance at Moody's.

In a sector where investment and earnings are tightly regulated, though, that exposure does not necessarily translate into "stranded-asset risk" for companies, Hempstead said July 14 during an online conference hosted by the Institute for Energy Economics and Financial Analysis, or IEEFA.

"The vast majority of the situations we've seen, the regulators have allowed recovery of these assets in some way, shape or form," Hempstead said. "So the impact of a large impairment or a write-off is relatively low, in our opinion."

Even so, utilities including Duke Energy Corp., which aims to achieve net-zero carbon emissions by midcentury, will have to engage in "comprehensive investor conversations" this fall to reconcile their climate goals with investments they plan to make in new resources, Julien Dumoulin-Smith, an analyst at Bank of America, said at the IEEFA conference.

"Gas assets are going to continue to decelerate," Dumoulin-Smith said, and revisions to utilities' integrated resource plans "are going to result in less gas" generation going forward.

Sticking with gas

As of late 2019, at least 200 new gas plants were planned or in development across the U.S., totaling nearly 70,200 MW of additional capacity — nearly equal to total generation capacity in Texas. If those assets are retired early, some worry utility customers will be stuck with hefty bills. But major utilities are not yet abandoning the fuel.

Natural gas "will remain an important part of our company's clean energy strategy," said Duke Energy spokesman Neil Nissan, as the company retires coal-fired generation and adds renewables and battery storage.

The company plans to file integrated resource plans in September for utilities in North Carolina and South Carolina, and "I can confirm that the IRPs will include multiple scenarios to support a path to a cleaner energy future in the Carolinas," Nissan wrote in an email.

Duke Energy generates 36% of its electricity from natural gas and fuel oil and 2% from solar and hydroelectric plants, according to its 2019 sustainability report. The company plans to devote 11% of capital expenditures to renewables, totaling $6.37 billion, though 2024.

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The rise of ESG investing has helped funnel money to renewable energy assets like these wind turbines near Reading, Kan.
Source: AP Photo

The breakup

While booming natural gas production drove a wave of power plant construction in recent years, the rise of environmental, social and governance investing is now helping to funnel capital into the renewable energy sector. Renewables represented half of global infrastructure deal flow last year, "making it the largest opportunity in the asset class by some distance," BlackRock Inc. said in a new report.

"Capital wants to go toward clean energy," Dumoulin-Smith said.

ESG considerations, as well as the need to support investment in areas such as renewable energy and energy storage, contributed to Dominion Energy Inc.'s recent decision to sell off its midstream gas assets, chairman, president and CEO Thomas Farrell II said. The sale was announced the same day Dominion and Duke Energy canceled the Atlantic Coast natural gas pipeline project due to legal and regulatory delays and rising costs.

"We are allocating capital in a way that supports our public environmental commitments," Farrell said July 6 on a call with analysts.

Under a law signed this year by Virginia Gov. Ralph Northam, all of the retail power sold by Dominion subsidiary Virginia Electric and Power Co., doing business as Dominion Energy Virginia, has to be carbon-free by 2045. Dominion, which aims to be a net-zero carbon emitter by 2050, plans to invest $9 billion in wind and solar plants and energy storage facilities through 2023, 35% of total capital expenditures during that period, according to CreditSights.

"The investment opportunity in the clean side in Virginia just became so large that it became obvious that they needed to break this company up, effectively," Dumoulin-Smith said.

'Somewhere there is a tipping point'

Dominion is not alone. A group of 20 utilities analyzed by Regulatory Research Associates, a group within S&P Global Market Intelligence, is allocating a combined $24.58 billion of capital expenditures to renewables this year and next.

James Robo, chairman, president and CEO of NextEra Energy Inc., which plans to spend an eye-popping $30.06 billion on renewables during a four-year period through 2022, has said falling battery costs will soon make "near-firm" wind and solar power cheaper, without incentives, than most existing coal and nuclear power plants as well as less-efficient natural gas-fired generators.

Unlike other industries, the utility sector "can disrupt itself profitably," Hempstead of Moody's said. "What prevents utilities from taking very large reductions and impairments and things of that nature related to some of their uneconomic generation is the fact that they have the regulatory [backing] that supports them."

However, their ability to avoid painful write-downs on bad assets will not last forever.

"Somewhere there is a tipping point where utilities will have more contentious discussions with their regulators with getting other cost recoveries through the regulatory process, because there's only so much that consumers are willing to tolerate," Hempstead said.