The utility industry hasn't changed much over the years. Power plants are built, transmission and distribution lines connect those plants to homes, and regulators set rates that maintain a utility's profit with almost no competition.
But over the last few years it has become possible for consumers to become power generators by putting up solar panels; by the end of 2015 over 1 million households will have done so. That is upending the status quo in utilities, and their response will be key for shareholders.
Southern Co. (NYSE: SO) faces the same challenges as other utilities, and for a while it fought the move to renewable energy. But as the company's first-quarter conference call indicates, it is making a necessary shift to embrace cleaner forms of energy.
"We are inventing the future of clean, safe, reliable, and affordable energy for the benefit of the customers and communities we serve. Our full portfolio strategy, which includes new nuclear and innovative new technologies for 21st century coal, as well as natural gas, renewables, and energy efficiency, is a fundamental component of that mission." -- Tom Fanning, CEO.
This was one of Fanning's opening comments in the conference call. Notice that words such as "clean," "renewable," and "efficiency" are now part of the common lexicon for utilities. This wasn't the case just a few years ago, and Southern was a leading proponent of new coal plants and nuclear power. But the focus has shifted as technologies such as wind and solar have become more cost competitive; executives now must embrace that future because it changes everything for their business.
Renewable energy is Southern's future
"Gulf Power and Mississippi Power recently announced power purchase agreements with solar facilities totaling 173 megawatts that are currently being developed on military bases in their respective states. Georgia Power broke ground at Fort Benning, the first of four 30-megawatt retail rate based solar projects in development with the U.S. Department of Defense. And there's more likely to come." -- Fanning.
Much of the conversation on the conference call focused on how much Southern is investing in renewable energy. This is important for a few reasons.
Renewable energy is becoming less expensive and more competitive on a cost basis, so signing power purchase agreements with renewable energy projects is now cost effective and lowers fuel cost risks. Owning projects with long-term power purchase agreements also ensures a rate of return over 20 years or more. That's attractive for utilities, whether it falls in the regulated or unregulated arms of the business.
Moving to renewables also lowers regulatory risk going forward. Tightening regulations have made it more difficult to build new coal and nuclear plants, so taking less risk on renewable plants is attractive for companies today.
Coal is dead
"Gas energy climbed to 48% of our energy production. Our use of coal for the quarter was the lowest in several decades, falling to 32% of our energy mix." -- Fanning.
Coal has been the driver of U.S. electricity growth for decades, but that run is over, as this quote indicates. I don't think this demonstrates weakness in Southern's strategy, but rather illustrates management's commitment to renewable forms of energy.
Growth is slowing
"Total weather-adjusted retail sales grew 1% in the first quarter, led by industrial sales, which were up 2%." -- Art Beattie, CFO.
For decades, utilities could count on 2% or more annualized demand growth from customers, but that's changing. Part of this is due to move toward energy efficiency, but the long-term challenge will be customers generating their own energy from rooftop solar.
That could reduce residential and commercial demand, which would leave utilities to spread existing costs over a smaller base of electricity deliveries. Keep an eye on this demand trend -- if growth slows or goes negative it's bad news for utilities.
Cost recovery for nuclear is strong
"On the regulatory front, $198 million in expenditures submitted in the 11th Vogtle Construction Monitoring Report were unanimously approved on Feb. 19, with a cumulative amount approved to date of $2.8 billion. Additionally, the procedural and scheduling order for the 12th Vogtle construction monitoring report was approved on April 7. Consistent with the long-standing Georgia law, the order reaffirmed that neither the project's certified cost, nor the VCM 8 stipulation in 2013 constitute a cost recovery cap." -- Fanning.
This comment involves the cost recovery for the Vogtle nuclear plant addition under construction. It is billions over budget and years behind schedule, but through something called Construction Work in Progress, Georgia Power can charge utilities for the cost of the plant and the overruns, provided regulators approve the costs.
The plan is great for shareholders because it reduces the risk of the new plant to almost nothing. Whether it's good for ratepayers is a story for another time (or see here).
Progress in transforming an old utility
Southern has made significant progress in transforming itself into a utility of the future, something investors should applaud. The ride might be a little rocky because demand isn't growing as it once was and returns from renewable plants aren't yet hitting the income statement, but I think the utility is moving in the right direction. Keep an eye on the rest of 2015 to make sure these investment trends continue.
Travis Hoium has no position in any stocks mentioned. The Motley Fool recommends Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.