OB Report
December 2021
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Electricity is All the Buzz

cokrainetz_sm By Cory O'Krainetz Equity Analyst, Investment Research

lightbulb-researchAfter several years of no growth, demand for electricity in developed countries is on the rise. We believe this trend will accelerate as electricity is used more extensively to meet our energy needs and help reduce our collective greenhouse gas emissions. Electricity has become the preferred choice of consumers and governments to power our economies as we transition away from fossil fuels.

A shift from gas-powered to electric vehicles (EVs) is a notable example. Demand for EVs is likely to surge in the years ahead, with car manufacturers planning to add at least 100 new electric car models in the next three years. At present, only 2.5% of the vehicles on the road in the United States are electric, and 5% of new cars sold are electric. President Joe Biden recently set a target of 50% for new cars sold being electric by 2030. The expected growth of electric vehicles would be enough to dramatically reshape how we consume energy, but it could be just the tip of the iceberg.

According to the International Energy Agency, roughly 63% of the world’s electricity is currently generated from fossil fuels. Nuclear and hydro consistently provide about 25% of our needs, and other renewables, such as wind and solar, represent 12%. This mix is changing fast, and renewable power generation is growing exponentially, displacing coal-fired power plants. 

Bloomberg estimates that the world needs to add at least 12,000 gigawatts (GW) of renewable energy by 2050 to meet growing electricity demand and reduce our dependence on coal. Total installed renewable power worldwide is just 3,000 GW today. Moreover, we believe this forecast will likely prove to be too conservative. Rapidly declining cost curves for solar, wind and storage mean that more places will be able to economically add renewables without government support or a sharp increase in electric utility bills.

The United States is a leading developer of renewables and is aggressively reducing its carbon footprint. Renewables increased from 10% to 20% of generation between 2010 and 2020. Over the same time period, coal fell from 45% to 20%. Natural gas has been used as a bridge fuel, increasing from 25% to 40%. We expect the growth of renewables to accelerate, as improving technologies have not only made wind and solar feasible, but in many cases, the lowest-cost option, too.

While it is easy to conceptualize switching from coal plants to zero-emission wind and solar farms, the transition won’t be easy. We need to build a smarter grid in order to connect renewable sources of electricity to consumers. This means incorporating advanced software to efficiently manage less predictable renewable power supply and match it with surges in demand. It also necessitates a more resilient grid with additional long-distance transmission lines, as well as energy storage to manage intermittency issues, allowing electricity generated during windy and sunny days to be saved and used at more appropriate times. We’re already seeing a growing network of EV charging stations so drivers can access power at all hours of the day. All of these changes should benefit electric utilities as they make investments to revamp their networks.

To participate in these emerging trends, we have identified two electric utilities uniquely poised to benefit and grow.

American Electric Power (NYSE:AEP)
AEP is a leading installer of renewable power and is one of the largest regulated electric utilities in the United States. With 40,000 circuit miles of transmission lines and 223,000 circuit miles of local distribution lines, AEP delivers electricity to 5.5 million customers. Together, the transmission and distribution businesses make up roughly 75% of earnings. We believe these are some of the most valuable transmission lines in the United States, which will only grow in value. The remaining 25% of earnings comes from independent power generation.

Solar and wind are the fastest-growing sources of new power generation. These projects tend to require large open spaces, often far removed from populated areas, making transmission lines critical to bringing renewable power to the market. Additionally, every dollar invested in AEP’s transmission and distribution network provides a robust regulated rate of return and predictable earnings growth.

AEP was once synonymous with thermal coal. In 2006, 70% of its power generation came from coal-fired power plants, but that has fallen to roughly 40% today and will be reduced to 15% by 2030 as plants are shut down. Management’s aim is to make AEP one of the most ethical businesses in the industry. It backs this goal by setting an extraordinary target of adding 16 GW of renewable power by 2030, enough electricity to power almost three million homes. This will bring AEP’s generation mix to 54% renewable power. We expect management to look for more options to completely eliminate its coal exposure and add even more renewables.

While it is encouraging that a major U.S. utility is taking steps to support a more sustainable future, it is also very profitable. By making regular investments in its assets, we believe AEP will be able to grow its earnings and dividend by 7% annually.

AES Corporation (NYSE: AES)
AES is a leading developer of renewable power and is focused on providing innovative solutions for the industry to help accelerate the shift to a more sustainable future. We think the company has one of the best growth profiles in the sector, targeting up to 9% annual earnings growth.

AES’s current backlog of renewable power projects is 8.5 GW and is one of the best in the industry. The company has also identified another 37 GW of development opportunities. These projects primarily consist of wind and solar power generation, along with utility-scale batteries. The company currently has coal in its power portfolio, but intends to reduce its exposure to 10% by 2025 and ultimately replace all coal with renewables.

Beyond its impressive renewable project backlog, AES is unique due to its entrepreneurial culture and focus on innovation. For example, the company spent several years, with partner Siemens, building an industry-leading battery storage business called Fluence. Fluence was recently brought to the market through a very successful IPO and is now valued at roughly US$6 billion. AES still owns a 34% stake in Fluence, and we expect the business to grow at a very attractive pace.

Fluence isn’t the only exciting opportunity. The company believes it has a similar growth opportunity through its investment in Australian-based 5B, which provides prefabricated solar solutions. The business allows utilities to install solar panels three times faster and use half as much land. The company currently owns 25% of 5B, and we think the outlook is very promising.

Uplight is another innovative company partially owned by AES. This business provides backend software support to over 80 of the world’s largest utilities. The technology enables an efficient connection of solar and wind-generated electricity to power grids with an ability to manage load variances. It also offers a customer interface that provides personalized information about customers’ energy use. Uplight makes electrical networks smarter and better able to handle the complexities brought on by renewables and a more engaged homeowner. AES has a 30% ownership stake in Uplight.

We think the businesses AES owns will provide significant value on their own. Additionally, they give AES the ability to provide industry-leading storage and best-in-class solar installations, and to enable smarter grids, which are significant competitive advantages when bidding on future renewable power projects.

sidebar-aaEvery year, we enjoy welcoming clients and friends from across BC to our Annual Address presentation series. Following the success of this year’s event and given the continually evolving public health landscape, we will be hosting our Annual Address virtually in February 2022.

We look forward to engaging in more interactive dialogue with clients, other attendees and our highly regarded Equity Analysts, in addition to sharing thoughts from President and CEO Debra Doucette (Hewson) and Executive Vice President, Director, Investment Research, Murray Leith.

Please stay tuned for more details, and we look forward to connecting with you in the new year.

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