By Karen Felton and Jaideep Malik, Ernst & Young LLP
Utility companies experienced a roller coaster in 2020. The sector largely outperformed the broader markets (S&P 500) through March last year, primarily supported by low interest rates and geopolitical uncertainty. However, since the COVID-19 pandemic, utility companies in the US have largely underperformed the broader markets, due to concerns of dramatic reduction in commercial and industrial customer load, as well as increasing bad debt during sustained shutoff moratorium periods.
As vaccinations increase, long-term demand trends should revert to historical patterns. In the near term, however, this means higher residential demand from a portion of the economy continuing to work from home, offset by the potential acceleration in energy efficiency and uncertainty around the overall manufacturing activity, commercial office usage and travel trends.
As 2021 unfolds, utility management teams should be following six trends:
COVID-19 effects will stay at the forefront and encourage greater stakeholder collaboration: The power and utilities industry has been profoundly affected by the COVID-19 pandemic – from demand and operational effects to dealing with a tidal wave of customers who are behind on payments. Utility companies are supporting a range of customer payment options and having to cost-effectively manage receivables and bad debt to preserve liquidity and the needs of customers.
As arrears continue to grow, utility companies will need to work through the financial impact of COVID-19 with regulators and communities in a fair and equitable way, while also accelerating customer experience initiatives. Greater collaboration with stakeholders to overcome the challenges brought on by the pandemic will also be key in strengthening trust with these groups as utilities look to evolve and secure their place in the future energy system.
Accelerated focus on clean energy investments: Growing concerns around climate change and decarbonization have made environmental, social and governance (ESG) performance a critical issue for utility companies. In the EY Realizing Strategy survey, energy executives were more likely than other industry executives (70% vs. 56%) to consider environmental and social issues to be as or more important than shareholders. As such, we expect to see continued disclosures of goals, improvement of previous targets and consensus around ESG best practices for the industry.
Additionally, renewables will increasingly become a mainstay for investment, whether for utilities looking for growth assets or non-utility businesses looking for diversification in sustainable businesses. In fact, the US ranked No. 1 in the EY Renewable Energy Country Attractiveness Index due to growing interest in and support for renewables.
Moving forward, these trends will continue, and ESG factors will play a greater role as utilities optimize their portfolio and adopt long-term value mindsets.
Technology advancements key to the energy transition and growth: The pandemic in some ways has accelerated the transition to low-carbon energy, but it has not changed the trajectory of technology developments. Before the pandemic, Ernst & Young LLP identified three tipping points that will change the business models of utilities in the US: the first, grid cost parity of non-utility solar plus storage systems, and the second, EVs reach cost and performance parity with combustion engine vehicles are slated for late 2020s and early 2030s, while the third tipping point – the cost of transporting electricity exceeds the cost of generating it and storing it locally – is expected after 2040. The electrification of transportation, buildings and industry along with other technological advancements will be necessary in reaching net zero in a post-COVID-19 world. Chief among the technologies necessary are battery storage, hydrogen and artificial intelligence – critical enablers in stabilizing grids as renewables grow. Moving into 2021 and beyond, utilities will need to invest in every aspect of their operations and demonstrate a sense of urgency in developing new business models and new technologies.
Merger and acquisition activity will gain momentum: In 2020, utility companies accelerated the back-to-basics or the simplification strategy that has been underway over the last decade. Several utilities announced plans to divest non-utility assets (e.g., midstream assets, merchant power fleet), which has generally been well-received by investors. In addition to the back-to-basics strategy, sector consolidation was another key M&A theme over 2010-18, largely to bring out cost efficiencies, strengthen core geography or build out regulated portfolios. The pace of activity slowed in the two years before the pandemic, which could be attributed to high valuations, uncertainty over gas infrastructure development, and project risks. However, given the recent stabilization of capital markets and an increased appetite for clean energy and regulated investment opportunities, there are many factors that suggest a more active deal market ahead. There will also be other tuck-in acquisition opportunities to build capabilities to bring additional products and services to market.
Capex opportunities will continue to drive growth for now: The fundamentals of the US power and utilities industry appear strong heading into 2021, given a robust capex outlook. Robust capital spending is being driven in five key areas: 1) accelerated fossil-based plant retirements requiring additional renewables, storage or natural gas generation given state policy goals; 2) build-outs of regional transmission networks to alleviate transmission constraints impacting renewables development; 3) system safety and reliability investments addressing storm hardening and aging infrastructure; 4) automation of distribution networks to enhance efficiency, customer service and reliability; and 5) increased resilience against cyber and physical attacks.
Talent and cybersecurity rise in importance as digital transformation accelerates: Digital adoption has accelerated across every industry due to the pandemic, and the power and utilities industry is no exception. The need for social distancing and keeping customers and employees safe has driven utilities to implement innovative and digital solutions to reduce human contact and turn themselves into “contactless” organizations. The transition to a truly contactless utility and to enable a more decentralized system will require investment in new and enhanced capabilities across the entire business. As utilities continue to increase digital investments in 2021 and beyond, they will need to give equal attention to talent and cybersecurity issues.
About the authors
Karen Felton is a partner in Ernst & Young LLP’s Consulting practice and serves as the EY Americas Power & Utilities Leader. She has more than 20 years of experience in the power and utilities industry helping companies transform their operations to integrate digital technologies and respond to changing customer and regulatory demands.
Jaideep Malik is a senior director at Ernst & Young LLP, focusing on the power and utilities sector. He has nearly 15 years of experience in strategy consulting and financial analysis, focusing on new business models, equity and asset valuation, and market analysis.
The views expressed by the authors are not necessarily those of Ernst & Young LLP or other members of the global EY organization.