Changes In Electricity Generation Take Time

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Includes: BAM, BEP, BRK.A, BRK.B, NEE, XEL
by: Eric Sprague
Summary

From 2009 to 2018, the U.S. added more natural gas MWh than wind and solar combined.

Renewable investments are more susceptible to the phasing out of tax credits than headlines indicate.

Matching the renewable supply with demand is an ongoing challenge.

Introduction

My thesis is that changes in U.S. renewable electric generation tend to take a long time and that investors need to be patient. Many recent predictions have been right about coal declining dramatically, but they have been overly optimistic with solar and wind. In terms of MWh additions over the last decade, natural gas has been ahead of renewables:

Energy Source

2009 MWh

%

2018 MWh

%

MWh Change

Natural Gas

920,979,000

23%

1,468,013,000

35%

547,034,000

Coal

1,755,904,000

44%

1,146,393,000

27%

-609,511,000

Nuclear

798,855,000

20%

807,078,000

19%

8,223,000

Hydroelectric Conventional

273,445,000

7%

291,724,000

7%

18,279,000

Wind

73,886,000

2%

274,952,000

7%

201,066,000

[a] Solar Thermal and Photovoltaic

891,000

0%

96,147,000

2%

95,256,000

[b] Other

126,372,000

3%

123,046,000

3%

-3,326,000

[a] Total

3,950,332,000

4,207,353,000

257,021,000

Spreadsheet Sources:

[1] EIA Electricity Net Generation

[2] EIA Electric Power Monthly

[a] Includes an estimated 29,543,000 MWh small scale Solar PV for 2018.

[b] Includes 11,928,000 MWh and 12,695,000 MWh "other" for 2009 and 2018, respectively, from [2] for the components to reach the [1] total.

The takeaways that stand out from 2009 to 2018 are as follows:

- Coal generation has declined by over 600 TWh.

- Natural gas has increased by almost 550 TWh.

- Wind has increased by over 200 TWh.

- Solar has increased by almost 100 TWh when including small-scale generation.

Here is a look at the progress wind and solar have made one year at a time:

Renewable Electricity Generation

Image Source: EIA Renewable Electricity Generation

Many forecasts on wind and solar focus on future cost declines, but variability and transmission are important parts of the system as well. Solar power stops being generated before the sun sets at which time demand increases voraciously. And the wind doesn’t necessarily blow when demand is high.

The Grid: The Fraying Wires Between Americans and Our Energy Future discusses the amalgamation challenges with respect to our grid which was designed for the previous century:

It was made to be managed according to a command and control structure. There was to be total monopolistic control on the supply side of great electric loop—which included generation, transmission, and distribution networks—and ever-increasing yet always-predictable consumption on the customer side of things. Electricity would move from one to the other, while cash would move in equal measure in the opposite direction.

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Wind

The cost of wind fell dramatically from 2009 to 2011. Since 2011, the cost has been coming down at a slower rate:

Lazard Wind Costs

Image Source: Lazard's Levelized Cost of Energy Analysis - Version 12.0

Solar

At the October 2015 Brookfield Renewable Partners (BEP) Investor Day, CEO Sachin Shah talked about why the company didn’t yet own solar at the time:

The solar space, we do believe will be a meaningful part of the supply stack longer term, a great diversification tool for system operators. It provides power typically when load is the highest during the day and the sun resource is the strongest. But again, like wind and more exacerbated than wind, the issue we always had with solar is that the unincentivized cost was uneconomic. You couldn’t build solar without incentives and we didn’t want to build a business that was wholly predicated on government support because as government support changes as policies change, it can really have a detrimental impact to returns and it can create an environment where you’re destroying capital for your shareholders.

Similar to wind, the solar costs fell dramatically from 2009 to 2011, but the cost reductions from 2011 to present have been more gradual:

Lazard Levelized Solar Costs

Image Source: Lazard's Levelized Cost of Energy Analysis - Version 12.0

Energy Myths and Realities: Bringing Science to the Energy Policy Debate was written in 2010 during the steep decline of solar costs yet author Vaclav Smil know that the rate of price declines would have to slow:

Gore implies that, analogically, the costs of photovoltaic electricity generation could be halved every eighteen months for decades to come. But the comparison is wrong, and the implication is impossible.

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Electricity demand tends to go up in the morning. During much of the day, it curves down slightly, but it goes back up in the late afternoon and tends to peak around sunset. In places like California, the supply of solar during the day means that the net load supply line heads down dramatically during the day such that it looks like the top of duck curve:

Electricity Duck Curve

Image Source: Vox Media

In much of the country, utility companies have to use more of the traditional forms of electricity generation to meet demand as we approach sunset. This is discussed in The Grid: The Fraying Wires Between Americans and Our Energy Future:

To meet this steady bump in demand, power plants ramp up everywhere in America just before five P.M. Unfortunately, it is also when the wind tends to slow down and, at certain times of year, when the sun starts its setting, making renewables without backup storage the least useful means of producing power at the most necessary moment of the day. Because we still lack a good system for storing renewable power, America’s evenings are powered by coal, natural gas, and the ever-present baseline of nuclear.

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The National Renewable Energy Laboratory talks about the flexibility of natural gas in particular:

Generally, natural gas combustion turbines, hydropower plants, and internal combustion engines are among the most flexible generators if not subject to other constraints, whereas coal and nuclear base-load units are among the least flexible.

In the long run, we need more than natural gas to cope with the capricious supply of renewables. Developing storage is going to be part of the solution, but we don’t know how long that will take to implement at scale.

Renewable Investments

Here are the 2017 global wind generation numbers for three of the biggest U.S. wind utilities:

41,336,711 MWh NextEra (NEE)

23,196,482 MWh Berkshire Hathaway Energy [BHE] (NYSE:BRK.A) (NYSE:BRK.B)

20,630,174 MWh Xcel (XEL)

I’ve been reading that wind and solar are so cheap now that tax credits aren’t needed. The renewable investment capex numbers I’m seeing from the above companies say otherwise as tax credits are phasing down:

2019

2020

2021

NextEra Wind

$2,235 Mn

$995 Mn

$20 Mn

NextEra Solar

$470 Mn

$150 Mn

$0 Mn

BHE Wind

$2,534 Mn

$1,864 Mn

$592 Mn

Xcel Renewables

$2,315 Mn

$1,105 Mn

$240 Mn

Spreadsheet Sources: NextEra, BHE, and Xcel.

Actionable Information

We've mentioned four companies throughout this article, and they all have extensive experience with non-coal energy assets.

Investors who are bullish on hydro should take a close look at Brookfield Renewable. CEO Shah implies that the world will continue to move away from coal when answering a question about its TransAlta (TAC) transaction in the 1Q19 call:

So look, I think the benefits of the transaction are that this will provide TransAlta with the capital you need to transition away from coal. And coal, as we all know, is a difficult asset class, it's difficult to finance. It represents an overhang on the stock. And the rating agencies and lenders are not thrilled about the outlook of coal for the broader business.

...

And I think in our transaction, the real benefit is that they source both capital and a partner who has expertise in renewable, and as they transition away from thermal, obviously, the future of electricity in every market around the world is going to be heavily underpinned by renewable technologies. And so this company needs to build that into its operating base, and we think we can assist in that regard.

One of the reasons I own stock in Brookfield Asset Management (BAM) is because it owns 61% of Brookfield Renewable, and the prospects of Brookfield Renewable moving forward look fantastic. U.S. investors with taxable accounts should be aware that Brookfield Renewable has a K-1.

Investors who are worried about upcoming recessions should consider Berkshire Hathaway. BHE is not a pure play because it is part of the larger Berkshire Hathaway parent. In some ways, there is a unique advantage here relative to other utilities. Having a large tax appetite, the Berkshire Hathaway parent can fully utilize tax credits from its BHE subsidiary. Investors looking for stocks that are expected to hold up will in bear markets should study the Berkshire Hathaway parent. It has around $100 billion in cash and it owns over 90% of BHE, which could be beneficial throughout hard times because people don't cut down much on electricity during recessions.

NextEra has done a tremendous job beating the S&P 500 over the last decade:

NextEra shareholder return vs the S&P 500

Image Source: May 2019 NextEra Investor Presentation

Seeing as many companies don’t have track records like this, NextEra deserves a closer look. If its cost decline numbers including tax credits are accurate, then the future is bright:

NextEra cost declines for wind and solar

Image Source: May 2019 NextEra Investor Presentation

We talked about the fact that cost declines in electricity generation alone are not enough. Storage is a key factor, but NextEra is optimistic in this area as well:

NextEra battery storage

Image Source: May 2019 NextEra Investor Presentation

Like many companies with renewable assets, NextEra mentions the depreciation advantages for wind and solar in its 10-K filing:

Pursuant to the U.S. federal Modified Accelerated Cost Recovery System, wind and solar projects are fully depreciated for tax purposes over a five-year period even though the useful life of such projects is generally much longer than five years.

This is an important consideration given the fact that other wind and solar tax incentives have been phasing down. NextEra has a big opportunity to take advantage of this solar depreciation benefit in Florida.

Eastern New Mexico, Eastern Colorado and West Texas have excellent outlooks for both wind and solar. Investors bullish on these geographic considerations should take a closer look at Xcel:

Geographic advantages for Xcel

Image Source: May 2019 Sustainable Long-Term Growth AGA Financial Forum

Here are some large Xcel wind projects in these geographically advantaged areas:

  • 478 MW | Hale, Texas | 2019 Completion
  • 522 MW | Sagamore, New Mexico | 2020 Completion
  • 500 MW | Cheyenne Ridge, Colorado | 2020 Completion

Closing Thoughts

Some headlines regarding renewables are overly optimistic, but Energy Myths and Realities: Bringing Science to the Energy Policy Debate reminds readers that energy changes cannot be rushed:

All energy transitions have one thing in common: They are prolonged affairs that take decades to accomplish, and the greater the scale of prevailing uses and conversions, the longer the substitutions will take.

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Disclosure: I am/we are long BAM, BRK.A, BRK.B, VOO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research.