Several North American regulated utilities have indicated that they intend to attain net-zero emissions targets in the future. And while these targets reflect important milestones toward energy transition, the path to net-zero may not be linear given the myriad of factors that some regulated utilities must effectively navigate to achieve this milestone, while preserving credit quality in the process.

Why Are Some Regulated Electric Utilities Pushing For A Net-Zero Carbon Future?

We think the movement toward net-zero reflects a broader shift to a low- to no-carbon future that some regulated electric utilities see as essential to their long-term ability to adapt to changing conditions. In addition, prior to the net-zero movement, many states had already indicated a desire to achieve some form of renewable portfolio standard (RPS) or to be carbon-free by a certain date (see table 1). Furthermore, some corporations which utilities serve as customers have expressed their desire to reduce their carbon footprint, and investors and property insurance providers have also indicated their preferences to either invest in or do business with utilities that are not considered carbon intensive. Finally, the Biden Administration has signaled its intent to move the U.S. toward a 100% clean energy economy and reach net-zero emissions no later than 2050. Overall, we view these collective factors as reasons why the net-zero movement among some U.S. regulated utilities continues to gain momentum.

Table 1

The net-zero focus is primarily among vertically integrated electric utilities

These are utilities that also generate the source of electric power in addition to providing transmission and distribution (T&D) service to customers. We make this distinction because other types of regulated electricity providers, mainly the T&D-only utilities are generally not considered to be large emitters of greenhouse gas emissions (GHG). This is not to say that the T&D utilities have no responsibility for GHG emissions either, since T&D utilities often procure electric power on behalf of the customers they serve through various purchased power agreements (PPAs), some of which may come from fossil-based sources.

Table 2

For these utilities, the path to net-zero begins with articulating a clear resource strategy that is beneficial for ratepayers

We believe this to be a first step on the path toward net-zero carbon emissions. This aspect seems straight forward but belies several complexities. Vertically integrated utilities typically make long-range plans on what mix of electric generating resources will be required to meet the demand for future electricity consumption. This is generally done through a process known as an integrated resource plan (IRP) which is required in several states (see map).

The focus of IRPs generally center around the concept of least cost planning or, stated differently, planning for power generation resources that ensure the least cost to ratepayers. As such, for some vertically integrated utilities, articulating a clear resource strategy on how they plan to achieve net-zero emissions within the context of an IRP is key. And even in states that do not require formal IRP filings, regulatory engagement on this issue is high, since IRP outcomes can influence what level of cost recovery support utilities receive for their decarbonization plans. Hence, moving forward on this path may require utilities to effectively demonstrate to regulators the cost benefits of such a move for ratepayers while managing regulatory risk, likely resulting in IRP plans that consider multiple scenarios, assumptions, environmental mandates, the development lifecycle of carbon reduction technologies, and other factors, all of which suggest complexity.

Closing down coal-fired generation is a logical next step toward net-zero

Arguably, the closure of coal-fired generation by utilities began before the net-zero movement. These efforts accelerated since the 2015 Clean Power Plan (CPP) was first announced by the then Obama-era Environmental Protection Administration (EPA), and vertically integrated utilities began making plans to either comply with more stringent environmental rules related to coal-fired generation or retire the coal fleets. Overall, we expect most utilities with net-zero targets will look to gradually exit coal-fired generation as a way to demonstrate progress toward achieving their net-zero goals. Indeed, some utilities have picked up the pace on this front, accelerating the timeline of coal plant closures. In June 2021, CMS Energy filed its IRP plan, indicating that it intends to exit coal by 2025, 15 years earlier than its current plan.

Chart 1

Chart 2

Renewable Generation Growth Will Remain Key For Affected Utilities' Net-Zero Strategies

The U.S. Energy Information Administration (EIA) projects that the share of renewables in the U.S. electricity generation mix will increase to 42% in 2050 from 21% in 2020, with wind and solar generation responsible for most of that growth. This projected growth generally aligns with the historical growth in wind and solar generation (see chart 1) among electric utilities. In addition, some utilities have signaled growth in renewable generation as an area of focus as they move toward achieving net-zero. For example, Duke Energy Corp. plans to double its renewable generation investments from 8,000 megawatts (MW) to 16,000 MW by 2025, and the company expects to add upwards of 40,000 MW of renewables by 2050, representing about 40% of the company's generation mix. Similarly, Dominion Energy plans to double the proportion of renewables that comprise its regulated utility rate base to 20% by 2025 from 10% today. And NextEra Energy Inc.'s regulated utility subsidiary Florida Power & Light Co. recently announced that it has achieved more than 40% of its "30-by-30" solar plan (installing 30 million solar panels by 2030). Overall, we think the growth of renewable generation will likely be a key area of emphasis on the path toward net-zero for affected utilities.

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The Role Of Nuclear Power Generation

The Biden Administration effectively acknowledged nuclear power generation as a carbon-pollution free energy resource in its American Jobs plan, announced in March 2021. We believe that nuclear power generation will play a role on the path toward net-zero for some regulated utilities. This means utilities such as Duke Energy Corp, Dominion Energy Inc., Xcel Energy, Entergy Corp., and Southern Co., all with similar net-zero targets by 2050, will continue to preserve their regulated nuclear power generation assets as key contributors on their respective path toward net-zero. That said, we view it as unlikely that big new nuclear power plants will be built anytime soon in the U.S. Southern Co. is the only utility company that is currently building two new nuclear power plants (Vogtle Units 3 & 4) in the U.S., a move that has been beset with challenges, including cost overruns and delays. Rather, we think what is likely to occur in the coming years is the gradual development of small modular nuclear power generation. For example, in September 2020, the Nuclear Regulatory Commission (NRC) issued its final safety evaluation report on a small modular reactor (SMR) design developed by NuScale Power (unrated). The SMR design is an advanced light-water small modular reactor capable of generating 60 megawatts of electricity. The NRC's safety report represents the technical review and NRC staff's approval of the SMR design, and upon receiving full certification, utilities will be able to reference the design when applying for a combined license to build and operate the new reactors in the U.S.

An Energy-Efficiency Investment Case Study

As the name implies, energy efficiency means using less energy to achieve the same output. For utilities, this means making investments that ultimately encourage customers to use less energy, alleviating the need to build or source more electric generating power. In January 2020, the New York Public Service Commission (NYSPSC) issued an order directing energy-efficiency targets and budgets for its New York regulated utilities. This order effectively followed the state's Climate Leadership and Community Protection Act (CLCPA) law which was passed in 2019 to address climate change. In response to the CLCPA, and the January 2020 order, Consolidated Edison (Con Edison) plans to spend $1.5 billion by 2025 to meet the state's energy-efficiency targets, and we expect such investments to be recovered through the regulatory process. We view the New York case as an example of how energy-efficiency investments could help support the transition to net-zero for affected utilities, in a manner that supports credit quality.

Technological Progress Will Likely Dictate The Net-Zero Transition Pace

We think technological progress would be the key factor that sets the pace of transition to net-zero carbon emissions for affected U.S. utilities. As part of the Biden Administration's push to decarbonize the U.S. economy, the Department of Energy (DOE) announced a series of initiatives aimed at speeding up the deployment of several clean energy technologies at scale. In June 2021, the DOE announced its "Hydrogen Shot" initiative, a program which aims to reduce the cost of clean hydrogen by 80% to $1 per 1 kilogram in 10 years. Then in July 2021, the DOE followed this with its "Long Duration Storage Shot" initiative, which aims to reduce the costs of grid-scale energy storage by 90% (from a 2020 lithium-ion baseline) for systems that deliver over 10 hours of duration within the next decade. Thus far, some utilities are starting to explore some of these technologies in various forms. Regarding hydrogen for instance, some utilities have communicated their nascent ambitions in the technology (see The Hydrogen Economy: Storage Is Paramount For Utilities In The Long Term, April 22, 2021).

Regarding battery storage, utilities' involvement has thus far been limited to small short-duration battery storage projects, but some plan to further develop in this area. For example, NextEra Energy Inc. subsidiary Florida Power and Light (FPL) owns a 10MW battery system (Wynwood Energy Storage Facility) that has enough energy to power about 7,000 homes for up to four hours. FPL is also building a 400 MW energy solar-powered battery storage facility (Manatee Energy Storage Center) expected to be in service by 2021. Similarly, Pinnacle West Capital Corp. subsidiary Arizona Public Service recently issued a request for proposal to acquire battery storage that can be combined with solar generation to add between 1000 MW–1500 MW of new resources to its system, and plans to install at least 850 MW of battery storage by 2025, a portion of which is expected to come through PPAs and retrofitting some of its existing solar-powered plants.

How Will The Path To Net-Zero Affect Credit Quality For Some U.S. Regulated Utilities?

As regulated utilities move forward on the path toward a net-zero carbon future, we see a few possible focal points in our analysis of credit quality. On one hand, as utilities execute on their net-zero strategies, we think these actions reduce environmental risk exposure over time. This could better position such utilities to meet current and potential future environmental standards, somewhat strengthening their business risk profiles. Case in point is NextEra Energy Inc., where we lowered the downgrade threshold for the current rating to funds from operations (FFO) to debt of less than 20% (from 21% previously), reflecting our view that the company achieved a modest improvement in its business risk profile by consistently reducing its ESG-related risks. On the other hand, we expect the implementation of the net-zero transition to lead to significant capital expenditures, which could strain financial measures, including for those companies that already have minimal financial cushion. In the end, our assessment of credit quality may hinge on how well utilities manage the pace of transition to a net-zero carbon future, including with regulators, investors, customers, and other interested stakeholders, without compromising their financial policy decisions and attitudes toward credit quality.