Regulated electric utilities tend to be safe, predictable companies that produce stable returns, which support growing dividends. But Dominion Energy (D -0.51%) has been far from a reliable stock.
The Virginia-based utility, which generated 57% of its 2022 operating earnings from electric distribution, transmission, and generation assets in Virginia and North Carolina, has been undergoing a strategic shift away from fossil fuels toward renewable energy as it seeks to support long-term growth. Expensive write-downs and declining earnings, paired with the strategic shift, have put immense pressure on Dominion Energy's stock, which is currently hovering around a 10-year low. However, bright spots are popping up on the horizon as Dominion's turnaround shows signs of coming to fruition.
Here's why Dominion Energy is an exciting turnaround play worth considering for investors who believe in the future of offshore wind.
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A new direction
Since unveiling its Grid Transformation Program in 2018 and then selling $9.7 billion of energy transmission assets to Berkshire Hathaway in 2020, Dominion Energy has been focused on investing in clean energy solutions to lower its environmental footprint. During last week's Q4 2022 earnings call, investors got a meaningful update on Dominion's largest renewable investment -- its 2.6-gigawatt project known as the Coastal Virginia Offshore Wind (CVOW) project.
The company said that CVOW construction is on schedule to be completed by year-end 2026. Investors should expect construction to begin in 2024 as planned.
On the Q4 2022 earnings call, Dominion Energy said that 90% of the project's costs will be fixed costs by the end of Q1 2023. The project's estimated installed cost is still $10 billion.
A closer look at CVOW's profitability
Dominion's energy transition efforts deserve to be applauded. And although Federal support for renewable energy is incredibly strong, a major headwind for Dominion is the steep upfront costs and the fact that CVOW has a high levelized cost of electricity (LCOE).
In its Annual Energy Outlook 2022, the U.S. Energy Information Administration (EIA) estimated that the unweighted LCOE for new resources entering service in 2027 would be $36.49 per megawatt-hour (MWh) for solar, $39.94 per MWh for combined cycle natural gas, and $40.23 per MWh for onshore wind -- even without factoring in tax credits. Dominion Energy expects that CVOW will have a much higher LCOE of $80 to $90. However, this is far lower than the EIA's average estimated unweighted LCOE of $136.51 for offshore wind projects entering service in 2027 -- a sign that CVOW is an above average offshore wind project.
The good news is that offshore wind projects are eligible for a much higher tax credit than solar or onshore wind, thanks to the energy investment tax credit. Offshore wind project developers like Dominion Energy that begin construction prior to Jan. 1, 2026, are eligible for a 30% investment tax credit (ITC) -- significantly bringing down the project's cost. There's also the production tax credit (PTC), which grants onshore and offshore wind energy projects a 2.6 cent per kilowatt-hour (kWh) credit for selling energy to unrelated parties for the first 10 years of electricity generation.
In addition to the federal tax credits, the Virginia State Corporation Commission is supporting the project by making sure Dominion is compensated for the project's steep costs. In August 2022, the SCC announced a new rate adjustment clause:
Over the projected 35-year lifetime of the project, for a residential customer using 1,000 kilowatt-hours of electricity per month, Rider OSW is projected to result in an average monthly bill increase of $4.72 and a peak monthly bill increase of $14.22 in 2027. The rate adjustment clause is effective for usage on and after September 1, 2022.
For context, Dominion estimated that its customers paid about 11.66 cents per kWh as of November 2020, or $116.60 per month for customers using around 1,000 kWh per month. So a $4.72 to $14.22 monthly increase isn't too steep.
What's more, Dominion estimates that the project could end up saving customers $3 billion to $6 billion on fuel costs in the first 10 years of operation since offshore wind projects don't incur fuel expenses -- whereas natural gas and coal projects do.
In sum, the project is expensive, but Dominion is getting a lot of support from Federal tax credits and state government agencies.
Offshore wind is worth the investment
CVOW remains an expensive, unproven project that is still several years from entering service. However, the offshore wind industry is nascent, especially in the U.S., where there are currently no major projects in service.
A decade ago, onshore solar and wind were not cost-competitive with combined-cycle natural gas. But both energy forms are now economically competitive even without tax credits. Offshore wind may not ever be as cheap as onshore wind. But at scale and with improvements over time, it too could see its LCOE dramatically decrease.
If all goes according to plan, CVOW will be one of the largest offshore wind projects in the U.S. With plenty of offshore wind leases available in Dominion's backyard off the coast of Virginia and the surrounding areas, CVOW could give the company critical operational expertise and experience if it decides to expand its offshore wind offering. All told, Dominion Energy is making the right long-term strategic decision.
It's also worth mentioning that Dominion's energy transition efforts were not an independent decision. Its Grid Transformation Program is directly supported by the Virginia Grid Transformation & Security Act, which provides tax credits for modernizing the grid. As a regulated electric utility, Dominion works with government agencies such as the State Corporation Commission, which influences the company's decision making. Since Dominion's renewable energy investments are directly supported by government agencies that are advocating improved reliability and clean energy, there are processes in place for cost recovery to ensure that Dominion isn't bearing all of the risks.
Dominion Energy is a buy for certain investors
Dominion Energy stock is bruised and battered, and it could take several years for the investment thesis to play out. However, the company ensured investors on its Q4 2022 earnings call that it would continue to support the current dividend -- which yields a hefty 4.5%.
The biggest risk facing Dominion Energy is whether or not renewable energy assets will produce comparable returns to its legacy natural gas and coal assets. For now, offshore wind (even with federal and state support) is simply not as profitable as coal and natural gas. And while the transition to wind energy is probably the right decision long-term, it is a major strategic shift for Dominion as a company that lacks offshore wind experience.
But given the direction that the electric utility sector is going, it's arguably better for Dominion Energy to rip off the proverbial bandage now and take advantage of the tax credits available instead of putting off what could very well be an inevitable transition.
For investors looking for short-term dividend raises and earnings growth, Dominion Energy isn't worth investing in. But for folks who are happy with the existing dividend and believe that the company's long-term strategic shift toward offshore wind and renewables is the right business decision, the dividend stock is worth considering now.
