Investors might have wondered why stock markets have performed relatively well in recent weeks despite the release of increasingly gloomy economic data. In my opinion, it's part wishful thinking on Wall Street, and part timing. States didn't begin issuing stay-at-home orders until mid-March -- almost exactly after most companies last provided quarterly updates to shareholders.
That'll change starting this week as companies start providing updates for the first quarter of 2020 and their outlooks for the new operating environment. One gauge of economic activity suggests investors should brace for more bad news: electricity consumption. In early April, the U.S. Energy Information Administration (EIA) issued its first projection of domestic energy market performance since the coronavirus pandemic started. The report expects 2020 will see the worst year-over-year decline in electricity demand since the Great Recession.
How will the coronavirus pandemic impact the power sector?
The EIA publishes a short-term energy outlook (STEO) each month with projections for liquid fuels, natural gas, electricity, and emissions in the current year. A major policy shift or international trade spat can inject a little variability from month-to-month, but the projections typically don't experience much change throughout the year. After all, the United States wields a massive, stable, and diverse electricity supply.
But these aren't typical times. According to the April STEO, the EIA expects total U.S. utility-scale electricity generation to decline by 3% in 2020 compared to last year. That might seem insignificant, but it's the equivalent of completely shutting off the nation's electricity for 11 days.
The largest declines in consumption are expected to occur among commercial and industrial customers (with drops from last year of 4.7% and 4.2%, respectively), which account for roughly 60% of electricity sales in a typical year. Surprisingly, the EIA forecasts residential electricity demand will decline 0.8% from last year, with milder winter and summer temperatures offsetting increases from stay-at-home orders. That matches data from January 2020 (the only month available as of this writing), which saw a 5% year-over-year decline due to milder temperatures this year.
Given the uncertainty and unprecedented nature of the situation, these projections could change with each monthly report. It's worth noting that American electricity consumption is always lowest in April, which just so happens to perfectly line up with stay-at-home orders. The timing of the coronavirus pandemic likely reduced its impact on the power sector, at least so far -- and the health crisis is still projected to drive the worst year-over-year decline in electricity demand since the Great Recession triggered a 4.1% decline in 2009.
If stay-at-home orders are extended into May or June, then the EIA may need to revise its forecast lower. Similarly, it's impossible to know how economic activity will change when stay-at-home orders are lifted. Will parts of the economy open in piecemeal fashion? Will consumers venture out with the same confidence as before? Will different regions rebound more quickly than others?
Broadly speaking, electricity demand is a reasonable gauge of economic activity. If these projections prove true, then investors can expect a significant economic slowdown in 2020. But energy investors might find a relative safe haven in renewable energy stocks.
A boom year for renewable energy
The EIA projects total U.S. electricity demand will decline 3% in 2020, but renewable energy is expected to grow 11% compared to last year. Why is there such a discrepancy?
First, power generators added a significant amount of onshore wind and utility-scale solar in 2019, and are expected to add record amounts in 2020. The nation's second-largest producer of energy from wind, Xcel Energy (NASDAQ:XEL), could bring over 2,300 megawatts of new wind capacity online from late 2019 to the end of 2020. That includes 1,822 megawatts this year.
The EIA projects the United States will add 19,400 megawatts of onshore wind capacity (easily a record) and 12,600 megawatts of utility-scale solar capacity in 2020 -- and that's after factoring in construction delays caused by the coronavirus pandemic. While much of the new capacity will come online at the end of the year, several gigawatts will begin making significant contributions well before December.
Second, renewable energy is the least likely power source to be curtailed in response to lower electricity demand. Onshore wind and utility-scale solar boast some of the lowest operating costs in many regions, primarily because they don't require fuel.
NextEra Energy (NYSE:NEE) produces more energy from the wind and sun than any other company on the planet. Its power generation subsidiary, NextEra Energy Resources, is one of the largest capital investors in the United States, and would rank seventh among countries by installed wind power capacity.
The renewable energy leader expects onshore wind and utility-scale solar to cost no more than $30 per megawatt-hour and $40 per megawatt-hour, respectively, by around 2024. That would make them the lowest sources of new electricity -- even after factoring in energy storage costs. Wind and solar aren't that inexpensive today, but they're very competitive economically.
Indeed, the EIA projects coal-fired power plants to produce 20% less electricity in 2020 than last year. Natural-gas power plants will see a 1% increase in output, but no-fuel-required renewable energy sources will grow 11%. That bodes well for electric utilities and power generators like Xcel Energy and NextEra Energy that are heavily reliant on renewable energy. Of course, investors shouldn't expect them to be completely insulated from negative impacts of the coronavirus pandemic, but it could go a long way to mitigating risks.
Investors should prepare for a bad year ahead
The stock market might be surprisingly resilient now, but that could change when companies begin reporting first-quarter 2020 operating results in the coming weeks. Businesses may not have been severely impacted in the first three months of the year, especially considering stay-at-home orders didn't go into effect until mid-March. But expectations for weak electricity demand suggests investors shouldn't be surprised if companies issue weak second-quarter and full-year 2020 guidance.
As for energy investors, the power sector is projected to have a relatively bad year. That said, renewable energy is expected to have a banner year of production, while stealing record market share from coal and making gains on natural gas. Investors shouldn't expect renewable energy to be completely spared from the coming economic downturn, but it could become a relative safe haven.