Last year was a roller coaster for utility companies in the US. The sector largely outperformed the broader markets (S&P 500) through March 2020, primarily supported by low interest rates and geopolitical uncertainty. However, since the COVID-19 pandemic hit normal life in the US, these companies have underperformed the broader markets over concerns of dramatic reduction in commercial and industrial (C&I) customer load (though offset by rising residential load as people work from home), as well as increasing bad debt during sustained moratorium periods.
As we look into the year 2021, we believe the fundamentals of the US utilities sector continue to be strong, given a robust capex outlook for these companies — increasingly skewed toward renewables, grid modernization and utilization of emerging technologies. These investments will not only benefit customers and support earnings growth, but also further companies’ environmental, social and governance (ESG) initiatives. From a demand perspective, as vaccinations are more widely available, we expect long-term demand trends to revert to historical patterns. In the near term, we expect higher residential demand from a portion of the economy continuing to work from home, offset by the potential acceleration in energy efficiency and uncertainty around the overall manufacturing activity, commercial office usage and travel trends.
Going forward, utilities will need to continue embracing clean energy technologies and grid modernization, as well as develop new business models focusing on customers’ needs to create value for shareholders.
The top focus areas for utility management teams should include:
COVID-19 effects will stay at the forefront and encourage greater stakeholder collaboration
The power and utilities industry has been profoundly affected by the COVID-19 pandemic. From demand and operational effects, to dealing with a tidal wave of customers who are behind on payments, the pandemic has impacted the industry in every corner of its business. As such, it could face a longer “echo effect” from the pandemic and encourage greater stakeholder collaboration. Utilities will need to continue to work through the financial impact of the pandemic with regulators and communities that’s sustainable, while also accelerating customer experience initiatives. Greater collaboration with stakeholders to overcome challenges brought on by the pandemic will also be key in strengthening trust with these groups as utilities look to evolve and secure their place in the future energy system.
Strategy will go “back-to-basics”
Over 2020, we saw several utilities making transformational announcements, accelerating the back-to-basics or the simplification strategy that has been underway for utilities over the last decade. Many key utilities announced plans to divest their non-utility assets (e.g., midstream assets, merchant power fleet), announcements that generally were well-received by their investors. Other utilities have focused on achieving greater operational excellence within the core business, driving down costs in line with the lower revenue projections associated with reductions in C&I load from the pandemic. However, as more utilities focus on their regulated models, there is a window of opportunity to expand the portfolio of products and services these companies offer to their customers, driving potentially higher revenues from the existing customer base (e.g., energy services, home solutions and smart products, distributed generation plus storage technologies, data analytics).
Focus on clean investments will accelerate
2020 brought significant disclosure from corporations to clarify their ESG positions. Even utilities highlighted their strong focus on ESG, as many of them hosted their first ESG investor days, developed presentations and reports for the ESG community, etc. We are seeing a strong alignment among policymakers, customers and investors on improving the environmental profile of the utilities, and we expect to see continued disclosures of goals, improvement of previous targets, and consensus around leading practices. Additionally, renewables will increasingly become a mainstay for investment whether for utilities looking for growth assets or non-utility businesses looking for diversification in sustainable businesses. In fact, the US ranked No. 1 in the latest EY Renewable Energy Country Attractiveness Index due to growing interest in renewables. Moving forward, these trends will continue, and ESG factors will play a greater role as utilities optimize their portfolio and adopt long-term value mindsets.
Capex opportunities will continue to drive growth for now
We are observing robust capital spending by utilities in five key buckets, including: 1) accelerated fossil-based plant retirements requiring additional renewables, storage, or natural gas generation given state policy goals and utility decarbonization and policy goals, 2) build-outs of regional transmission networks to alleviate transmission constraints impacting renewables development, 3) system safety and reliability investments addressing storm hardening and aging infrastructure, 4) automation of distribution networks to enhance efficiency, customer service and reliability, and 5) increased resilience against cyber and physical attacks.
Merger and acquisition activity will gain momentum
Sector consolidation has been dramatic over 2010-18, largely to bring out cost efficiencies, strengthen core geography or build out regulated portfolios — but pre-pandemic the pace of activity has slowed significantly. This could have been driven by high valuations, uncertainty over gas infrastructure development, and project risks. However, given the recent stabilization of capital markets and an increased appetite for clean energy and regulated investment opportunities, there are many factors that suggest a more active deal market once we get to the other side of the pandemic. Also, there will be other tuck-in acquisition opportunities to build capabilities to bring additional products and services to market.
Talent and cybersecurity rise in importance as digital transformation accelerates
Digital adoption has accelerated across every industry due to the pandemic, and the power and utilities industry is no exception. The needs for social distancing and keeping customers and employees safe have driven utilities to implement innovative and digital solutions to reduce human contact and turn themselves into “contactless” organizations. The transition to a truly contactless utility and to enable a more decentralized operating model will require investment in new and enhanced capabilities across the entire business. As utilities continue to increase digital investments in 2021 and beyond, they will need to give equal attention to talent and cybersecurity issues.
Technology advancements are key to energy transition and growth
The COVID-19 pandemic in some ways has accelerated the transition to low-carbon energy, but it has not changed the trajectory of technology developments. Before the pandemic, we identified three “tipping points” that will change the business models of utilities in the US: first, “grid cost parity” of non-utility solar plus storage systems, and second, electric vehicles reach cost and performance parity with combustion engine vehicles are slated for late 2020s and early 2030s, while the third tipping point — the cost of transporting electricity exceeds the cost of generating it and storing it locally — is expected after 2040. The electrification of transportation, buildings and industry along with other technological advancements will be necessary in reaching net zero in a post-COVID-19 world. Chief among the technologies necessary are battery storage, hydrogen and artificial intelligence — critical enablers in stabilizing grids as renewables grow.
