The United States is in the midst of a historic energy transition away from fossil fuels to low- and zero-carbon electric power. In 2020 alone, the nation could add 20,400 megawatts of onshore wind capacity and 12,700 megawatts of utility-scale solar capacity, according to the U.S. Energy Information Administration (EIA). 

That would be a record volume of additions (assuming the coronavirus pandemic doesn't delay construction timelines), but it creates one significant challenge for future renewable energy growth: transmission capacity. It's often overlooked in the discussion of renewable energy stocks, but transmission is one of the largest sources of planned capital investment for many power generators through 2035. 

Considering transmission is accounting for an increasing share of revenue and earnings growth for many electric utilities, it's something investors need to begin paying closer attention to.

A row of wind turbines in a grassy field.

Image source: Getty Images.

Build power assets, curtail energy, build transmission, repeat

Unlike thermal power plants, the location of wind and solar farms is dictated by geography. That can create challenges when assets are erected in rural areas far away from roads, major population centers, and existing power lines. Unfortunately, much of the country's best geography for wind and solar power production is located in areas that historically haven't been an integral part of the nation's grid infrastructure.

That has created local and regional problems in clean energy distribution. Take Texas as an illustrative example. The state is home to over 29,000 megawatts of onshore wind power capacity, which represents 27% of the total in the United States and is more than all but four countries. 

By 2010, Texas had installed more than 14,000 megawatts of wind power capacity. Half of that came online from 2006 to 2009 and was primarily located in West Texas, which lacked adequate transmission lines at the time to transport electricity to the state's population centers to the east. That led to some wonky market dynamics. 

In the first half of 2011, the Electric Reliability Council of Texas (ERCOT) -- the regional grid operator -- was routinely curtailing 2,000 megawatts of wind power per hour. Electricity prices averaged negative $10 per megawatt-hour during that span. 

By 2014, Texas installed more than 3,500 miles of new transmission lines to ease congestion and reduce curtailments in the ERCOT system. In fact, the new transmission lines in the state helped to raise the national average utilization rate for wind power from less than 30% in 2010 (reflecting curtailments) to 34% in 2014. 

That might be an extreme example -- or not. Similar congestion and curtailment challenges have cropped up in California and the Midwest in recent years as the build out of new wind and solar power capacity infrastructure outpaces transmission capacity. 

With a record 33,000 megawatts of utility-scale renewables slated to begin operations in 2020, investors might expect more curtailments in the near future. Luckily, the industry has big plans to install tens of thousands of miles of new transmission in the coming years and invest heavily in another under-the-radar technology.

A worker standing under transmission lines.

Image source: Getty Images.

These companies are investing (big) in transmission

An electric utility generates revenue and earnings from its rate base, which is the total value of generation, transmission, and distribution assets. Each type of infrastructure has a unique regulatory mechanism to recover invested capital. When a company invests to maintain or upgrade its infrastructure, then it can earn a rate increase (meaning the prices charged to customers) from state regulators. A larger rate base is generally more valuable. 

That's important because transmission assets are likely to become the largest part of the rate base for many companies in the near future. Xcel Energy (XEL 0.09%) expects its rate base to grow from $30 billion in 2019 to $42 billion in 2024. Transmission assets will grow from 25% to 27% of that total, which suggests the total value of transmission assets will grow 51% in that five-year span. 

The roughly $4 billion capital investment in transmission infrastructure through 2024 will be dwarfed by the next major build out. Xcel Energy estimates it could invest $15 billion to $20 billion in transmission assets from 2025 to 2035. 

The plan would enable more renewable energy assets to be built in the regions in which its four electric utilities operate and replace aging and less efficient assets. In fact, Xcel Energy's transmission build out is one of four strategic priorities through 2035. The other three receive more attention among investors, such as adding wind and solar, deploying energy storage technologies, and preparing for electric vehicle growth. 

Xcel Energy can justify up to $15 billion of capital investment in transmission infrastructure because it operates in the American wind corridor and sun-soaked West, which has plenty of untapped potential for new renewable energy assets. Transmission will be important to companies in other geographies, but there are other ways to address congestion and curtailment challenges. 

An offshore wind farm.

Image source: Getty Images.

Eversource (ES 0.10%) operates primarily in New England. The region has less favorable renewable energy potential compared to other parts of the country, lacks pipelines for natural gas, barely relies on coal-fired power plants, and has several nuclear retirements scheduled. If any region requires a retooling of transmission infrastructure relative to population density, then New England is a good bet. 

The company has responded with $9.3 billion in capital investment in transmission infrastructure from 2001 to 2018. That has driven transmission-related earnings from just $28 million in 2004 to $427 million in 2018. That was roughly 41% of total earnings in that year. 

The business has another trick up its sleeve: energy efficiency. Closely tied to updating transmission infrastructure, energy efficiency has allowed many power generators across the country to retire coal-fired power plants without needing to replace them with additional power assets. 

Eversource currently spends 5% to 7% of total revenue on energy efficiency alone -- easily the most in the nation. That has earned the company and its subsidiaries several accolades, including most energy efficient utility in the United States (Eversource Massachusetts) and top energy efficiency provider in the United States (overall company average). 

The investments in transmission infrastructure and energy efficiency have fortuitously positioned Eversource to capture a major opportunity somewhat unique to New England: offshore wind energy. Today, the United States operates only 30 megawatts of offshore wind capacity, but an opening of permits and new partnerships has pushed the country's current project pipeline to over 23,000 megawatts. Much of that could be built by 2030.

Although more expensive to build, offshore wind power has a handful of advantages. It can operate at a relatively high utilization rate (matching or besting fossil fuel plants), can be positioned close to major population centers (many cities are on located on coasts, including on the Great Lakes or major seas), and doesn't displace land from other uses (fishing aside). Eversource is forging ahead with up to 4,000 megawatts of offshore wind power projects. 

A globe with wind turbines sticking out of it.

Image source: Getty Images.

Investors can no longer overlook transmission

While the United States has some of the best geography for wind and solar power on the planet, power generators and electric utilities can't just throw up some wind turbines and start raking in money. Adequate transmission and distribution infrastructure needs to be in place, but that often lags behind the initial build out of generation infrastructure.

Luckily, even though it may not be on the radar of many investors, companies such as Xcel Energy and Eversource are taking the challenge seriously. The pair have committed tens of billions of dollars in capital investment in transmission infrastructure for the regions in which they operate. Many of their peers have or will soon follow. 

Simply put, as renewable energy power capacity grows by record volumes in the 2020s, investors will need to begin paying closer attention to transmission infrastructure. Without it, wind and solar farms might be significantly less valuable.