OB Report
December 2022
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The Power to Change

cokrainetz_sm By Cory O'Krainetz Equity Analyst, Investment Research

In September, we attended the Wolfe Utilities and Clean Energy Conference in New York. Flying coast to coast, it was hard not to notice North America’s vast geographic diversity and contemplate that each region is powered by its own unique electrical grid. As you might expect, hydroelectricity accounts for more than half the grid power on both coasts. Inland, it is starkly different, with windmills and fossil fuels generating most of the power. The infrastructure currently in place to move power from one place to another hasn’t changed much over the last 50 years, and those connections will remain relevant for many more years. However, the way we think about electricity in the context of climate change is changing rapidly.

At the conference were the CEOs of the biggest and most influential companies in the sector. Hearing from them provided great insight and perspective on some key themes around the global energy transition. It took decades to build our existing energy infrastructure, and it will likely take decades to re-power the world with clean energy. According to the International Energy Agency, roughly 61% of the world’s electricity is generated from fossil fuels. Nuclear and hydroelectricity provide 25% and non-hydro renewables bring just 14%.1 This demonstrates a tremendous opportunity to green our electricity supply and add new power to meet growing demand. While this will be a massive undertaking, the industry is planning clean energy investments at a breakneck pace of at least $1 trillion2 annually over the next decade.

The Wolfe Conference coincided nicely with the passing of the Inflation Reduction Act in the United States, which is viewed by many as a game-changer for clean energy. Tax credits and incentives will total over $700 billion. We think it is the most important bill ever passed in the U.S. to help tackle climate change and support the development of clean energy.

While higher interest rates, supply chain constraints and volatile energy prices present new hurdles, we believe the path to a cleaner future is emerging. Moreover, there is greater motivation to devise a plan for a global energy transition and spend capital more wisely. Renewables are not only the best option for the natural environment, but also the most cost-effective.

North American utilities will be a big part of the solution. The grid we saw from 20,000 feet is aging and desperately needs upgrading to handle an influx of renewable power and greater electricity demand. U.S.-based coal plants are being replaced with wind and solar farms, which is great news for consumers, investors and the planet we all share. Implementing renewable sources of power is now half the cost of a typical coal-fired power plant. And connecting clean power to electricity-thirsty homes and businesses should keep utilities growing for many years. Imagine the power we will need to charge all the new electric vehicles coming over the next 20 years!

The companies we spoke with at the Wolfe Conference are investing heavily in four key areas: (1) wind, solar and storage in the grid; (2) rooftop solar; (3) nuclear; and (4) hydrogen.

Wind was the first renewable resource to really take off. Windmills have steadily replaced heavily polluting coal-fired plants. Today, solar is the new leader, as the technology and cost structure have improved dramatically. Both sources are being rolled out aggressively, but they are intermittent, and output varies widely by region. Energy storage is the missing link to successfully managing that reality. The grid needs major upgrades to accommodate these new sources and manage surges in supply and demand, and the technology now exists to make that happen.

Rooftop solar is another avenue of growth. Much like utility-scale solar, costs are coming down and countless companies now offer systems to homeowners and businesses. However, the initial cost is significant. Installers typically provide payment plans to spread the cost out over many years. In addition, homeowners and businesses often keep connected to the grid so they can sell power to utilities during the day, which helps offset their cost.

Rooftop solar will likely evolve into a network of micro-grids between homes and businesses, allowing them to generate, manage and store power, as needed. While some view this as a threat to traditional utilities, we see a need for both to meet increasing demand and believe the networks can work effectively together. Longer term, rooftop solar could be a major part of the solution in sunnier areas. For instance, California has been the leader in rooftop solar thanks to its climate, high electricity prices and a desire to reduce its dependence on fossil fuels.

A global renaissance in nuclear energy is underway. There is a growing appreciation for stable, carbon-free baseload power, such as nuclear, to support renewable sources. Historically, natural gas and coal have filled this role, but with sky-high energy prices and European gas shortages caused by the war in Ukraine, countries are rethinking their optimal power mix.

U.S. providers of nuclear power are big winners in the passing of the Inflation Reduction Act, which provides tax credits when the price of electricity is low, essentially putting a floor under earnings. In addition, one executive at the Wolfe Conference noted that most existing nuclear plants have longer lifespans ahead than new renewables being constructed today. Both points suggest a positive long-term trend for nuclear energy.

Hydrogen produced from electricity is the latest innovation, and everyone in the industry is looking to participate. It is the most abundant element in the universe, and engineers are looking at ways to profitably commercialize the fuel source. Hydrogen is collected by combining electricity with water to separate it into its basic H2 and O elements. “Green” hydrogen is produced when renewable power is used, whereas “pink” hydrogen uses nuclear energy. It’s a simple process, but the amount of energy needed is a stumbling block, as is the ability to store and transport the gas afterwards. There is greater incentive to solve these problems thanks to a massive $3/kg tax credit provided in the Inflation Reduction Act, which reduces the cost of production by about 75%. Hydrogen is used for various industrial purposes and could be broadly adopted for commercial transportation. Another intriguing application is energy storage that would allow electricity to be produced when resources are abundant, stored as hydrogen and then sold when power supply is scarce.

We think investors should seek to participate in these trends. Contact your Odlum Brown Investment Advisor or Portfolio Manager for the specific recommendations in our coverage universe that might be suitable for you.

1 https://www.iea.org/data-and-statistics/data-tools/energy-statistics-data-browser?country=WORLD&fuel=Energy%20supply&indicator=ElecGenByFuel

2 https://www.iea.org/data-and-statistics/data-tools/investment-data-explorer

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