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Vertically integrated Investor-Owned Utilities (IOUs) across America are raking in record-breaking profits under the guise of the so-called “energy transition.”
From 2014 to 2024, earnings for American electric utilities have more than doubled, growing at more than 15 percent per year for the last three years, largely due to surging spending on new wind turbines, solar panels, and natural gas plants.
These numbers are such a deviation from the slow-and-steady industry that electric utility companies are supposed to be that Morningstar had to ask in 2023, are “Utilities Suddenly A Growth Sector?” As Travis Miller explained in the article, the tremendous growth in earnings in the electric utility sector is driven by electrification efforts and renewable energy investments and likely will be for some time if the trend continues:
Utilities are never going to rival tech companies or biotech companies in terms of growth. But this is the best utilities growth environment that we’ve seen in decades. When you combine those big macro themes of electrification and clean energy, we’re seeing utilities with growth prospects that we haven’t seen in many, many, many years. And these aren’t just growth prospects for the next year or two. This is growth that we think can last for a decade or more. A lot of the clean energy goals and the electrification goals out there right now are 2040, 2050 goals. When you look at all of the infrastructure investment that’s needed to get to those goals, this is a long runway of growth for utilities, perhaps more so than any other sector.
Emphasis added.
The link between utility profits and capital spending is nothing new. Utilities are generally on board with efforts to support the so-called “energy transition” because it gives them the perfect excuse to build as much as possible, which is the primary way they earn profits.
IOUs may have investors, but they aren’t really private companies. They are government-approved, vertically integrated monopoly utilities with the exclusive right to sell electricity in their service territory.
Because customers have no choice but to buy their power from the monopoly, it would be unfair to let the company charge whatever it wishes for electricity. As a result, electricity prices are generally set by government regulators using a mathematical formula called the Cost-of-Service formula.
In its most basic form, the formula states that utilities are allowed to charge enough for their electricity to cover the cost of providing the service to everyone in their service territory, plus a government-approved profit, often five to ten percent, on their capital investments. As long as the expenses are approved by the regulator in their state, utilities make a profit on every dollar they spend on new builds such as wind turbines, solar panels, natural gas plants, or even renovating corporate offices.
The more money utilities spend, the more money they make.
On the other side of this equation is depreciation. Every year, the company pays off a little bit more of the plant, and as a result, they no longer profit from this depreciated capital expense. The graph below is a hypothetical power plant on a 30-year depreciation schedule. The utility makes a cool $11.25 million in corporate profits in the first year, but by year 31, the asset is entirely depreciated, delivering no returns for shareholders.
Once a power plant is paid off entirely, the utility no longer makes any profit from the facility. From the perspective of customers, fully depreciated power plants offer some of the lowest-cost sources of electricity on the grid. From the perspective of the utility, they’re no longer a means for growing earnings. As a result, utilities have a powerful financial incentive to work against the interest of their customers by retiring reliable, low-cost existing generators so they can spend as much money as possible building new infrastructure to put in their rate base, thus maximizing their government-approved profits.
The desire for regulated companies to pursue non-productive and capital-intensive projects is now known as the Averch-Johnson Effect. This effect is also often referred to as “Gold-Plating,” based on the somewhat sarcastic idea that a regulated firm might plate its building and fixtures in gold simply because gold is more costly than other materials.
However, the latest wave of “Gold-Plating” has more of a greenish tint to it. In today’s version, wind and solar provide the inefficiencies utility companies are looking for. Utilities are now Green-Plating™ their grids, and the fact that wind and solar are unreliable is an incredible bonus because it means they get to retire depreciated assets and build far more capacity to replace them than would normally be necessary.
Let’s consider an example of retiring a 10-megawatt (MW) coal facility that is completely depreciated. Replacing this plant with wind and solar allows the utility to build 10 MW of wind, 10 MW of solar, and 10 MW of natural gas to provide reliable power during the inevitable periods when wind and solar are producing zero power.
This new grid allows utilities to spend $44.17 million and triple the installed capacity on their system with new, undepreciated assets to do the same job as the coal plant they just retired.
The graph below demonstrates the inefficiencies of replacing reliable coal facilities with a mixture of wind, solar, and gas. The graph uses 10 MW of demand as a proxy for coal generation. Hourly generation from wind and solar is based on recent conditions observed in the Midcontinent Independent Systems Operator (MISO), and natural gas fills in the gaps.
With the potential for windfall profits from building unreliable assets, it comes as little surprise that utility companies across America are making voluntary pledges to go carbon-free “for the planet.”
The map below from the Smart Electric Power Alliance shows utilities that have pledged to achieve 100 percent carbon-free, net negative, net-zero, or reduce emissions.
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