In a new research report, Steve Kihm of Madison think-tank SeventhWave and Andy Satchwell of the Lawrence Berkeley National Laboratory argue that the shift to clean energy could hurt utility stock-prices if it leads to a decline in capital investments. In an exclusive interview with Entelligent, they explain the challenges facing utilities in a decarbonizing economy.


Give me a quick recap of what your research shows.

Steve Kihm: Wall Street analysts study utilities’ market value, but most regulators don’t focus on how their actions impact stock prices. That was the innovation we offered: a model that speaks regulators’ language, but factors in variables that investors care about.

Andy Satchwell: Our project addresses the question of how to align utilities’ profit motivations with public policy goals. We’re looking at this question through the lens of investor value, which in turn is driven by return on equity and cost of equity. 

SK: Our key finding was that utilities’ capital investments are an important driver of stock-market performance, but the significance varies considerably from utility to utility. The difference between cost of equity and return on equity is where the value engine works: if your return is more than your costs, then the more capital you can cycle through that engine, the better for you and your investors. If the difference in those returns is small, declining rates of investment won’t cause much market value loss; on the other hand, if the gap is large, declining investment will cause noticeable reductions in market value.

AS: What we found was that as utilities reduce their investments, the impact on stock prices can be quite severe. Utilities typically invest about 4 percent of revenues in capital expansion or to replace existing assets. For the most aggressive scenario we tested, where future investments fell to zero, we found stock prices could fall by almost 54 percent.


And could the shift to clean energy leave utilities with less capital cycling through that value engine?

SK: Our report is silent on the reasons investment might fall, but you’ve identified something people are definitely thinking about. If we have lots of distributed clean-energy resources coming in and providing capacity that utilities would otherwise have provided, that could cause the kind of slowdown that we’re describing. 

AS: That underpins a lot of what we’re talking about. Utilities are thinking about several different kinds of impact, including revenue erosion — and of course energy efficiency and distributed resources could reduce their future earnings opportunities.

SK: That throughput disincentive — with utilities selling fewer kWh, and thus finding it harder to cover their costs — can be remedied in a variety of ways. But if utilities respond by cutting back on investments, if they stop building things, that could be a biggerproblem. 


How big a deal is this for utilities? 

SK: Something to bear in mind is that utilities won’t necessarily respond to the push for clean energy by reducing investment. If their solution to decarbonization is to build cleaner power plants, that could be a huge capital investment that would solve the problems we describe. The key, if you’re a utility CEO, is to strategically address that challenge. If you hunker down and stop adding capital, then that’s when our model shows you could run into trouble.


So these are solvable problems? 

SK: Well, one thing that wouldn’t be solvable would be if capital investment dried up. The regulators are not going to intervene to dramatically increase returns on equity, so there are definitely scenarios in which utilities couldn’t be made whole.  

AS: There are already places — like Minnesota, New York and California — where regulators are thinking about this, and considering changes to more explicitly and directly align the utilities’ financial motivations with their public policy goals. 

SK: The key is to realize that there are plenty of ways to respond to decarbonization without cutting investment. Grid modernization, for instance, could involve billions of dollars of capital investment, and all that capital could produce value for the utilities and their shareholders. 


Are utilities doing enough to steady the ship? 

SK: The biggest risk would be for a utility to stand still, and let the world change around them, but I don’t think too many utilities will let that happen. Utilities are very aware that these shifts are taking place. We aren’t banging a drum that wasn’t already being drummed. We are quantifying the potential impacts. 

AS: This question speaks to conversations folks have been having — in boardrooms, or in front of regulatory commissions — for several years. 

SK: The utilities need to be looking at the alternatives — if the business-as-usual approach, pushing electrons through the grid, isn’t going to work, then what other business models are available and viable? These are questions that utilities and regulators need to be working on. 


Your paper suggests struggling utilities could increase rates — might that make options like distributed solar even more attractive to consumers?

AS: An increased cost to ratepayers would change the equation for a lot of things, including improving the customer economics for distributed solar. The possibility of a positive feedback loop whereby increased adoption of distributed solar would lead to greater utility revenue erosion — the “utility death spiral” — isn’t something we go into in our analysis, but it’s something regulators and policymakers should be aware of. It’s a critical piece of the balancing act. 

SK: By focusing on market value, we’ve elevated the debate to a level that’s quantifiable — and we could run the things you’re talking about, like the risk of a “death spiral”, through our model. So far, we’ve only cut into the first layer of what’s really a multi-layered cake — we’re still just in the frosting, but as we cut deeper, we’ll be able to start to answer these big questions for investors.


Boil it down for me: what does all this mean for energy investors?

SK: That’s the ultimate question for your readers! Our research shows a possible downside scenario for investors: if the clean-energy transition means capital is invested by distributed-resources companies like NRG (NYSE:NRG) or SolarCity (NASDAQ:SCTY), and that displaces conventional utility investment, then investors should be aware that it’s likely to erode utility value. 

Still, specifics matter. Investors should look at regulators and utilities’ planning, and at their competitors. If that adds up to a situation where utilities aren’t adding as much capital, then our research says their stocks will likely take a hit. We haven’t answered the question about what will happen — instead, we’ve presented a complex question back to investors, saying these are the things you need to be looking at.

Ben Whitford is the US correspondent for The Ecologist. He has written for the Guardian, Newsweek, Mother Jones, Slate, and many other publications.