The energy sector is undergoing a massive paradigm shift -- and investors need to know where their money's headed. A new survey highlights what industry leaders consider to be their three biggest challenges -- here's what you need to know.
Study the source
There's a lot of speculation on where the energy sector is headed, but a new Siemens Aktiengesellschaft (NASDAQOTH:SIEGY)-commissioned study heads straight to the source. The "State of the Electric Utility" report pulls institutional knowledge from 527 utility professionals to answer what everyone wants to know: How different will our electricity look in the next year, decade, and beyond? And more importantly, what are the biggest challenges to getting there?
1. Current regulatory model
The energy sector is changing fast, and regulators have been slow to keep up. Thirty-two percent of all those surveyed pointed to the "current regulatory model" as a major challenge for their corporation.
In the past, utilities have operated on a kWh sales-based model, pulling a certain profit percentage off every sale. But the days of easy earnings are over, and investors can no longer count on their coveted "return-on-equity" metric to separate good investments from bad ones.
Decentralized power grids and energy efficiency systems have shifted utility costs away from primary generation and more toward distribution and energy diffusion.
Eighty-three percent of those surveyed noted they plan to grow their energy efficiency programs over the next five years, while 53% listed distributed generation as the "most disruptive potential" to their company's current business model.
But utilities need regulators to keep up, and providing the proper incentives for energy companies to engage with customers is essential. Regulators are warming up to new ideas, but their ability to create a supportive regulatory environment will directly determine how fast and how wholeheartedly utilities can boost new business models.
2. Distributed generation
Rooftop solar systems have been called the "killers" of utilities -- and some would agree. Thirty percent of respondents listed "distributed generation" as a top three challenge for their utility. Interestingly, though, a larger majority are up for the challenge. In a follow-up question, the report found that 57% view distributed generation as an opportunity for investors, compared with just 38% who view it as a threat.
That's great news. That subtle distinction is the difference between an old utility unwilling to budge its business, and a forward-thinking company ready to capitalize on a new energy paradigm.
While some utilities such as Xcel Energy and Pinnacle West are looking to financially punish decentralized energy generators to make up for lost earnings, others are partnering up to push their own products. NRG Energy acquired rooftop solar company Roof Diagnostics Solar two weeks ago, and Dominion Resources, (NYSE:D) is leasing rooftop space directly from Virginia companies to install its own systems. For example, the company announced in December that it will spend $2 million to slap 2,000 solar panels on the rooftop of a Canon facility.
3. Old infrastructure
Utilities have been around for ages -- and that means aging infrastructure. According to the report, 48% of all respondents listed "old infrastructure" as a top concern for their company.
The worry here is twofold. First and foremost, aging electrical systems are unreliable at best, and dangerous at worst. As natural gas becomes an increasingly important part of our utility system, that problem becomes even more prevalent.
A recent New York Times report found that between Consolidated Edison (NYSE:ED) and National Grid (NYSE:NGG), the top two New York City natural gas distributors, the companies reported a whopping 9,906 leaks in 2012 alone. These leaks can be lethal, as evidenced by a Consolidated Edison pipe explosion in March that leveled two East Harlem buildings and killed eight people.
But while utilities understand that old pipes are problematic, finding the finances for upgrades can be a regulatory nightmare. Almost half of Consolidated Edison's New York City pipes were installed before 1940, and the company is having a hard time coming up with the $10 billion needed to fully renovate its network.
With lackluster electricity demand growth and continued tough times for America's average electricity consumer, politicians are hard-pressed to approve rate increases to cover the costs of systems that seem to have operated effectively for more than a half-century.
The new energy leaders
Despite difficulties ahead, there are companies out there that are capitalizing on the current trends -- and are set to pull major profit. Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg.
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Justin Loiseau has no position in any stocks mentioned. The Motley Fool recommends Dominion Resources and National Grid. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.