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Electrifying the Net-Zero World

As the energy utilities sector prepares for a vital role in the low-carbon economy, are its transition plans meeting investor expectations?

As the world becomes more aware of the devastating impacts of climate change and accelerates its shift away from fossil fuels to renewable energy, electricity will become the core of our power generation infrastructure.

The sector is the solution to powering the world in a more sustainable way, but it’s also the biggest culprit behind current levels of carbon emissions, accounting for three-quarters of global tonnage, according to the International Energy Agency’s (IEA) ‘Net Zero by 2050’ roadmap report.

Although investors recognise that drastic change can’t happen overnight, the important role utilities will play in the transition means that “they need to be decarbonising at a faster rate than the rest of the economy”, warns Carlota Garcia-Manas, Head of Engagement at Royal London Asset Management (£148 billion AUM).

As well as this, utilities need to be rapidly upscaling their capabilities in order to ensure the “electrification of much of the economy”, agrees Colin Baines, Investment Engagement Manager at Friends Provident Foundation, a UK charity focused on sustainable economic development.

It’s therefore vital that electricity utilities are in a strong position to meet surging demand via resources and processes aligned with a net-zero world.

For investors to accurately assess a utility corporate’s commitment to net zero, their specific interim targets and investments in renewable alternatives, Baines notes that comprehensive energy transition plans are “a necessity”. The jury’s still out on the degree to which investors are willing for energy transition plans to rely on carbon offsetting and carbon capture, utilisation and storage (CCUS) technologies.

“If a company is to have longevity, then not decarbonising isn’t an option. Investors need to know about [the utility’s] business model resilience and its management of risks and opportunities,” he says.

Bolstering capacity

If energy utilities are able to formulate and follow through on an effective transition plan, they will be in sight of a major opportunity. The IEA predicts that almost 90% of global electricity generation in 2050 will come from renewable sources, with solar PV and wind accounting for nearly 70%.

But to handle expected demand, the IEA roadmap forecasts a need for annual additions to solar PV capacity of 630 gigawatts (GW) by 2030, with wind power also adding 390 GW of capacity each year.

So far, renewable electricity capacity is growing in tandem with demand, with an IEA market update noting capacity grew by 45% in 2020 to 280 GW, the largest year-on-year increase since 1999. China accounts for 50% of the renewable energy capacity added in 2020, the IEA said.

In the longer term, carbon-intensive sectors such as automotive, steel and mining will require vast amounts of electricity to enable their own transitions to more sustainable operational processes and products.

This anticipated growth in demand offers a myriad of opportunities for market expansion, new jobs and, for the investor, strong financial returns as the cost of renewables goes down and the level of demand goes up.

“[Net zero] will require huge increases in electricity system flexibility – such as batteries, demand response, hydrogen-based fuels, hydropower and more – to ensure reliable supplies,” the IEA said.

If the world is going to reach net-zero greenhouse gas (GHG) emissions by 2050, global annual clean energy investments need to more than triple by 2030 to around US$4 trillion in order to support the rate of growth needed, the IEA said.

The perfect plan

To reach this golden opportunity, energy transition plans need to adequately disclose utility firms’ current carbon emissions levels, their interim targets for reduction and percentage of revenue committed to exploring renewable alternatives, experts say.

Plans shouldn’t be “overly reliant” on offsets and negative emissions technologies, Baines tells ESG Investor, but should focus more on corporate lobbying, capital expenditure (Capex) and remuneration strategies in the short to medium term.

Capex in relation to fulfilling net-zero targets is a particularly important consideration for investors, agrees Treasa Ni Chonghaile, Senior Portfolio Manager at KBI Global Investors (€12 billion AUM).

“How much of an investment commitment has the utility made to their decarbonisation targets? How do they plan to shut down their fossil fuel capacity and maintain financial returns?” she asks.

KBI Global Investors also assesses the level of commitment to transition by board management. Increasingly corporates are aligning management remuneration with the company’s sustainability goals, which Ni Chonghaile notes is “a key indicator of the corporate’s commitment”.

Most importantly, interim targets made by utilities need to be informed by science-based evidence provided by the likes of the Science Based Target initiative (SBTi), according to Kevin Bourne, Head of Sustainable Finance at research and analysis firm IHS Markit.

Industry-level collaborations such as the Transition Pathways Initiative (TPI) or the Climate Action 100+ Net Zero Benchmark are also a useful way for investors to quickly identify whether a utility corporate is following through with the commitments in their energy transition plans, Garcia-Manas points out. “It helps us compare the quality of follow-through on targets made by our utility investments with their peers,” she says.

The CA100+ Net Zero Benchmark further highlights the quality of ESG-related disclosures corporates are providing in line with Task Force on Climate-related Financial Disclosures (TCFD) guidelines.

Large cap companies are more likely to outperform a benchmark, as they have more access to the necessary resources and the funds to ensure more rapid decarbonisation when compared to smaller corporates in the sector, Bourne explains.

“Processes such as SBTi are good indicators but we should also be realistic about what small cap companies can deliver,” he says.

Evidence suggests a number of global utilities are taking the transition to net zero seriously.

For example, as part of a collaborative engagement with RLAM and the Friends Provident Foundation, UK energy company SSE revisited its net-zero targets last November and published an updated report, providing more detail on its contributions to flexibility, carbon storage and demand side response, as well as its principles and plans to support a just transition.

More recently, a growing number of US utilities – such as Edison International, Avangrid and NRG Energy – are committing to the International Capital Market Association’s (ICMA) principles for green, social and sustainability bonds. This means firms are linking the cost of debt finance to the achieving of metrics directly related to the decarbonisation of their operations.

Investor opportunities

The renewables space is increasingly attractive as the costs of tapping wind and solar energy decline. Utility companies therefore need to disclose detailed costings of ESG-related financial opportunities within their energy transition plans, as well as their level of risk.

“When looking at transition plans, it’s always good to see plans for significant majority renewable generation, energy storage, flexibility, new gas limited to small scale peak power, smart grids, local energy, demand management, and services,” Baines says.

The break-even costs of solar- and wind-power generation have declined by 90% and 70% respectively, according to John Hancock Investment Management (US$164.5 billion AUM). This is because, beyond the upfront construction CapEx needed, renewable power generation has no ongoing fuel costs and fewer operating expenses than more carbon-intensive equivalents.

“Critically, because they’re regulated entities, electric network utilities may offer investors the potential to earn attractive, stable returns for years to come,” the firm wrote.

NextEra Energy, one of the largest renewable operators in the United States, has estimated that it will be cheaper to build and operate brand new onshore wind or solar farms than to operate an existing coal plant as soon as 2025.

As outlined in its 2020 stewardship report, RLAM has a great exposure to utilities because of these opportunities, Garcia-Manas says.

“We recognised that, as an investor, we have a real opportunity to place our bets on the fact that the decarbonisation of the global economy simply can’t be done without the decarbonisation of electricity utilities. The future relies on electrification. We see our investments as an opportunity to influence the acceleration of decarbonisation,” she tells ESG Investor.

Technologies in their infancy 

A number of utility corporates, such as UK-based Drax, are investing in the development of bioenergy with carbon capture and storage (BECCS) technologies to remove carbon dioxide from the atmosphere while transitioning to renewable electricity.

However, with such technologies largely untested at scale, investors remain divided as to the extent to which utilities should be relying on underdeveloped technological solutions to fulfil their decarbonisation targets.

CCUS and BECCS technologies, while seemingly viable solutions on paper, are far from reliable methods of decarbonisation, according to experts.

These storage technologies work by capturing carbon from fuel combustion or industrial processes, transporting the carbon via ship or pipeline, and then either repurposing it as a resource or permanently storing it deep underground.

There are risks associated with this, largely involving the possibility and management of carbon leaks. Furthermore, similarly to purchasing carbon offsets, this doesn’t actually reduce the amount of carbon produced by companies relying on these technologies.

“The debate about CCUS has been going on for a very long time with very little to show for it, other than acting as a drag on the transition to renewables,” says Baines, adding that investors need to be “quite forceful” with laggard electricity utilities in order to avoid an overreliance on carbon offsets and hopes for CCUS.

The cost of implementing CCUS or BECCS is also something investors must consider, explains Paola Perez Pena, Principal Research Analyst of Clean Energy Technology at IHS Markit.

“If we define effective technologies by their capacity to eliminate total CO2 emissions during operations, then the effectiveness will vary significantly by sector and it will affect the abatement cost. As CO2 concentration decreases in an emissions stream, more energy is required to separate CO2, thus affecting the overall emission reduction numbers and increasing the unit cost,” she says.

No time to waste

With the IEA calling for electricity utilities to be completely decarbonised by 2040, many argue there simply isn’t time to waste on developing these technologies and implementing them at scale.

That isn’t to say that technological innovation won’t play a key part in the transition to net zero in the longer-term, Perez Pena acknowledges.

“Even the most conservative scenarios, with high dependency on renewables to meet net-zero, estimate that CCUS technologies will be required to reduce emissions, mainly from hard-to-abate industries such as cement and iron production. For the power generation sector, CCUS most likely won’t be essential, due to the high costs; […] however, this could vary by region based on the power plant age. For example, countries with young power plants may find CCUS could be a relevant solution to reduce emissions while keeping plants operating,” she says.

For now, CCUS and hydrogen are “technologies in their infancy”, says Swami Venkataraman, Senior Vice President of ESG Analytics and Integration for Moody’s Investors Service. Realistically, they won’t be a viable option for utilities before 2030.

But there’s plenty utility corporates can be doing to decarbonise their operations and products now, Venkataraman adds.

“There’s a relatively clear path for utilities in the short- to medium-term: their strategy is to shut down coal power plants and build in more renewables and some natural gas,” he says. “Utilities can still hit shorter term interim targets without major technological breakthroughs by deploying increasing amounts of battery storage, which is steadily becoming more economical. It’s the time between 2030 and 2050, and actually reaching net zero, that remains challenging. That’s when new technologies will be needed.”

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