Houston residents are marveling at a new energy-efficient home that features everything from a solar panel-lined roof to smart thermostats. The kicker? The home was built by a utility company. Why would Reliant Energy, a firm that makes money on power, provide a way for consumers to use less of it? (And in Houston, of all places?) Because the rise of price-competitive renewable energy has forever changed the game for utilities. In their next act, they will no longer be able to make money by investing in ever-more fossil fuel-burning plants—but will instead have to find a way to provide value to consumers while staying ahead of new competition.
The utilities sector has always adhered to a simple principle: The more you invest, the more you earn. Due to prohibitive fixed costs, the sector operates as a natural monopoly consisting mainly of regional players. These firms are heavily regulated by state-run public utility commissions, which control virtually every part of a utility’s business—from signing off on investments to setting rates of return. Because utilities are allowed to generate a fixed rate of return on their assets, more assets mean greater returns. This model is particularly advantageous at a time of declining interest rates and earnings yields. It’s little wonder why since 2004, annual capex by U.S. investor-owned utilities has more than doubled—and why investors have flocked to these stocks as bond alternatives.
The sector suffered an initial scare coming out of the Great Recession, when utility professionals feared that rising energy prices would incentivize consumers to switch to renewable energy. At issue were the forced “buyback” programs by which consumers who generated their own power could sell it back to the utility. (Fully 42 states plus Washington, D.C. had implemented such programs in 2010.) Sure enough, as energy prices spiked and ever-more consumers adopted solar power systems, utilities like Arizona Public Service and Denver-based Xcel Energy began asking regulators to reduce incentives or impose new charges on consumers who installed solar rooftops.
Naturally, when fossil fuel prices plummeted in late 2014, utility executives breathed a sigh of relief. No longer would renewable energy hold a comparative advantage over fossil fuels.
Or so they thought. In the years since, it has become jarringly evident that the game has changed for utilities—and there is no going back.
In spite of falling energy prices, the shift toward renewables has not only continued—but has accelerated. Global renewable capacity rose by 9 percent YOY in 2016, powered largely by solar. For the second consecutive year, renewable capacity accounted for more than half of all capacity added worldwide. Fully 1 million solar installations took place in the United States last year, a figure that the Solar Energy Industries Association expects to double by the end of 2017. Renewables have truly arrived in green states like California, where regulators anticipate that 85 percent of consumers will be getting at least some of their electricity from a source other than an investor-owned utility by 2020.
How has this happened? For one, productivity gains in renewable energy generation are proceeding so rapidly that renewables remain price-competitive no matter how low fossil fuel prices go. According to Greentech Capital Advisors partner Jim Long, “In 2010 we financed a 15-megawatt solar plant in southern California that cost $55 million to build…This year we have done another one the same size in the same area that has cost $15 million and will produce at least 40 percent more energy.” Moreover, continued advances in energy storage have made it ever-easier—and ever-cheaper—for consumers to go “off the grid.” (See: “Energy Storage Powers Up.”)
Another factor is generational change. America’s rising appetite for renewable energy is being fueled by Gen Xers and Millennials—each for different reasons. For individualistic Xers, renewables promise self-sufficiency: If the grid goes out, a backup generator or solar power could mean the difference between life and death—or at least between comfort and hardship. This generation’s prepper, me-against-the-world mentality is the same one that has brought “survivalism” into the mainstream. (See: “I Will Survive.”)
Meanwhile, renewable energy is a natural match for Millennials who value sustainability and urban living. Pew Research finds that consumers ages 18 to 29 favor the development of alternative energy sources over the expansion of fossil fuels by 54 percentage points, by far the widest margin of any age group. The mere mention of fossil fuel elicits a negative reaction from young Millennials: According to Ernst & Young, 16- to 18-year-olds have a much less positive perception of natural gas (40 percent positive) and oil (25 percent) than older consumers (60 percent and 35 percent, respectively).
Attitudinally, Millennials are interested in living sustainably and leaving a small carbon footprint. Their land-use patterns reinforce this worldview: This generation’s affinity for urban living naturally leads to less dependence on utilities. Because of the compactness of city life, the average New York household uses less than half of the electricity consumed by the average U.S. household (4,700 kWh compared to more than 11,000 kWh).
Does this shift toward renewables mean lights out for utilities? Not quite. Fossil fuel-generated power still creates 85 percent of the world’s energy, a share that will not disappear overnight. Clearly, however, fossil fuels are no longer a growth driver for utilities. Instead of investing ever-more heavily in fossil fuel-powered plants in order to generate a profit, the sector must find another revenue stream.
Best-practice firms are betting that consumer-facing services will be their next cash cow. The average consumer spends only 20 minutes each year interacting with their energy provider. Utilities want to extend and deepen this relationship—even if it means offering services that encourage less power consumption. Southern California Edison offers a digital home energy advisor tool that provides tailored recommendations for reducing household energy usage. Duke Energy and American Electric Power are now market-testing a new mobile app that offers everything from bill pay to real-time outage updates. Accenture global managing director Tony Masella says that, “Utilities are really beginning to realize that the world has shifted…It’s not something that will happen in five years. It’s happening now.” An industry trade survey found that only 5 percent of utility professionals say that their business model does not need to evolve.
While becoming “energy-service providers” may garner firms some much-needed favor among consumers and state regulators, there’s no guarantee that this strategy will pay off. Utilities are monopolies in energy provision, not in service provision. Their direct access to consumers’ homes and their knowledge of the power business does give them an early advantage. But unless utilities can use that head start to build a truly meaningful relationship with consumers, they may be marginalized once third-party tech companies with vastly more experience in digital IT begin competing in the space.