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What a Biden presidency could mean for utilities

Charles Fishman CFA  |  20 Oct 2020Text size  Decrease  Increase  |  
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A victory by Democratic candidate Joe Biden in the coming US presidential election would mean some changes for utilities, but nothing that we believe would significantly change our long-term view for utilities investors. We think the challenges for utilities executives will be in three areas: renewable energy, taxes, and natural gas supply.

Renewable energy

The biggest contrast between President Donald Trump and Biden is probably environmental policy. However, we believe the differences are more political bluster than actual changes to the mix of power generation. Trump has touted himself as the saviour of the coal industry; Biden said in the first debate that no more coal plants will be built under his administration. The reality is that no new coal plants are being built anyway, and hundreds have been retired or will be retired in the coming decade. Coal generation and carbon emissions have fallen substantially since Trump took office.

We believe growing renewable energy, cheap natural gas, sluggish power demand, and emissions regulations will continue to crowd out coal as utilities use more renewable energy and natural gas for electricity generation. By 2030, we forecast renewable energy will pass coal, nuclear, and hydro as the second-largest source of power generation in the US regardless of who is sitting in the Oval Office. We estimate 8 per cent annual renewable energy growth (excluding hydro) during the next decade.

Natural gas and renewable energy Top Morningstar's 2030 Power Generation Forecast

Our bullish renewable energy forecast is based on state renewable energy policies as the primary growth driver—not the federal government, the Paris Agreement, or the Green New Deal. Biden’s energy platform calls for the US to reach net zero carbon emissions by 2050. But the majority of utilities in the US have already made this pledge, and we expect more to follow regardless of who wins the presidential election.

In the first debate, Biden declined to support the Green New Deal, a plan introduced by Rep. Alexandria Ocasio-Cortez (D-N.Y.) and Sen. Ed Markey (D-Mass.) that would require a faster rate of decarbonisation. There doesn’t appear to be broad Democratic support for this acceleration. We suspect a Biden presidency would balance decarbonization with the economy and jobs.

Continued decarbonisation of power generation will have to acknowledge the importance of reliability, especially after a summer of blackouts in California. Land requirements for wind and solar are significant, requiring these projects to be located in areas with lower population density. Transmission is key to bringing the power where it is needed. A recent Federal Energy Regulatory Commission report delineated the challenges in permitting and building new transmission to support renewable energy. Biden wants more renewable energy, but Trump likes infrastructure. Thus, we don’t believe there would be a significant acceleration in wind and solar construction beyond our already bullish view under a Biden presidency.

Taxes

The second key difference between Biden and Trump is that corporate income taxes are likely to increase if Biden is elected president, Democrats win control of the Senate, and Democrats retain their majority in the House of Representatives. In the long run, customers' utility rates incorporate the corporate taxes that utilities pay. So just as the Trump tax cuts lowered customer rates, eliminating the Trump tax cuts would increase customers' utility rates over the long term.

However, taxes are complex and the near-term rate impact is not straightforward when combined with other utility rate-making considerations. In 2018, when corporate tax rates dropped from 35 per cent to 21 per cent, utilities collected lower taxes from customers. An increase in tax rates implies higher collections from customers, as regulators seldom contest this expense. That being said, we expect regulators might require utilities to defer some of the customer rate increases until the economy has completely recovered.

When tax rates went down, utilities found themselves with an overcollection of taxes from customers, or excess allowance for deferred income taxes. Most regulators allowed the overcollection to be returned over fairly long periods, and some of these liabilities remain on utilities' balance sheets. These could be used to reduce the impact of higher taxes. However, unique to utility rate making, allowance for deferred income taxes is an offset to the rate base and partially offsets rate increases from higher corporate income taxes.

The increase in the collection of deferred taxes increases cash flow and benefits the balance sheet. Thus, a tax increase would theoretically reduce the amount of equity needed for investment.

Natural gas supply

A Biden administration will probably pursue policies to limit natural gas production. However, the most likely outcome—restricting drilling on federal land—is a heavily watered-down version of the full fracking ban that some Democrats have called for. And as gas-directed drilling mainly occurs in states with little to no federal land exposure, this policy change would have little impact on natural gas prices for customers.

Going further would require congressional support, as fracking is otherwise regulated at the state level. It’s quite likely at this point that the Democrats would also control the Senate in the event of a Biden win, but even then, we see little chance of an outright ban on fracking. The threats to the economy, unemployment, and energy security would be as unpalatable to most moderate Democrats as they are to Republicans.

Most natural gas distribution utilities have dramatically stepped up pipeline replacement investment for safety reasons since the 2010 gas explosion in San Bruno, California. Falling natural gas prices provided the headroom in customer rates for utilities to recover a return on higher levels of investment, while keeping overall customer rate increases below inflation.

One example is Atmos Energy, the regulated natural gas distribution utility serving Dallas. We estimate Atmos Energy will almost double capital expenditures during 2020-2024 versus the past five years, with most of the incremental investment for pipeline replacement. However, all-in customer rates in 2024 will be about what they were in 2008 even if natural gas prices increase to US$4.50-US$5.50 ($6.40-$7.40) per thousand cubic feet. Thus, we expect regulators will continue to approve Atmos’ accelerated investment, especially since most of the capital expenditures are earmarked for safety and reliability.

In general, higher natural gas prices are a negative for the utilities industry. However, as with Atmos, we believe most utilities should be able to find other cost savings to moderate customer bill increases and maintain their investment plans.

Electric vehicles

Electric vehicles play a key role in Biden’s US$2 trillion Build Back Better clean energy plan. Biden has suggested that the EV plan execution would be similar to US Senate minority leader Chuck Schumer’s (D-N.Y.) US$400 billion Clean Cars for America proposal to take 63 million internal combustion engine cars off the road by 2030—nearly one in every four cars in the US Biden has suggested paying car owners to retire old cars, creating incentives for manufacturers, electrifying buses, and supporting EV rebates.

Biden’s one specific EV infrastructure target is reaching 500,000 public EV charging stations nationwide with help from utilities. We think this goal is exceptionally aggressive within an eight-year, two-term period. However, even reaching half of that goal is a huge investment opportunity for utilities. The cost of that goal would vary widely depending on whether those charger stations are in home, which cost about US$2,000 with installation, or public fast chargers, which can cost more than US$100,000.

is a Morningstar equity analyst.

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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