American Electric Power plans to operate its 2,900-MW John E. Amos coal plant in West Virginia for the foreseeable future. Morgan Stanley analysts say the utility has a large opportunity to accelerate earnings growth by shutting down coal generation and investing in clean energy.

Source: S&P Global Market Intelligence



Morgan Stanley & Co. LLC forecast that about 70,000 MW to as much as 190,000 MW of coal-fired generation is "economically at risk" from the deployment of a "second wave of renewables" in the U.S. under three of the more likely scenarios in a recent analysis. The research firm said these projections exclude about 24,000 MW of coal generation already set to shut down.

"Driven by the surprisingly low cost of renewables, we believe that carbon-heavy utilities that have not historically led the pack in clean energy deployment will accelerate their earnings growth by pursuing a 'virtuous cycle': shutting down expensive coal plants and investing in cheap renewables," Morgan Stanley analysts wrote in the Dec. 10 research report.

Morgan Stanley sees American Electric Power Co. Inc., Dominion Energy Inc., Southern Co., Pinnacle West Capital Corp., PPL Corp. and Duke Energy Corp. as the utilities with the "largest opportunity" to achieve a valuation rerating under this approach.

"What we've found is, now there is a much greater opportunity to achieve kind of a triple-bottom-line benefit in the sense of customers [through lower bills], the environment and shareholders," Morgan Stanley analyst Stephen Byrd said in a Dec. 18 interview. "There is an opportunity now that we think some utilities will seize on. We don't know for sure, but we see that opportunity, and we see the benefit that other utilities have achieved with their share price performance that have embraced that opportunity."

'Driven by economics'

Byrd noted that the firm's research was driven in part by the "very active debate" around the future of renewable energy and the future of fossil fuels.

NextEra Energy Inc.'s acquisition of Gulf Power Co. in Florida and the "pretty dramatic change" to the acquired utility's carbon profile while "tripling the growth rate" also caught the attention of Morgan Stanley analysts, Byrd said.

"We were wondering, 'Is that a broader driver? Is that kind of economic potential really there?'" Byrd said.

In addition, management teams often talk about the evolution and economics of renewables as recent requests for proposals have shown encouraging results for clean energy, Byrd noted. Energy investors also have "significant" interest in the environmental, social and governance practices of electric utilities and power providers.

As a result of these factors, Morgan Stanley said it conducted an "in-depth, asset-by-asset assessment of the coal fleet" in the U.S. using a fixed or "all-in cost of coal" approach in three of five scenarios that it views as the more likely outcomes.

The base-case scenario in Morgan Stanley's research shows about 70,000 MW of coal capacity at risk by 2030, while a scenario that includes a $40/ton price on carbon shows 192,000 MW of total coal capacity at risk.

Under the base-case scenario, coal-fired electricity declines from 27% of the total U.S. power mix in 2018 to just 8% by 2030. The firm predicted that wind and solar will grow from 9% to 30% of the generation mix over the same time frame.

"Our base case is really just driven by economics," Byrd said.

Regional breakdown

On a regional basis, Morgan Stanley said it sees the greatest amount of coal "at risk" and the greatest opportunity in the Midwest.

The firm sees the levelized cost of electricity for wind hitting as low as $20/MWh by 2024, while the current average all-in cost of coal plants is $30/MWh.

"Given this dynamic, we see 34 GWs of coal capacity likely at risk by 2030 under [the base-case scenario], growing to 74 GWs in a scenario with a $40/ton carbon price," analysts wrote.

"From a timeline perspective, wind in the Midwest was the first extremely cheap renewable resource we had," Byrd said.

Xcel Energy Inc. represents a good example of a utility that took advantage of the low cost of developing new wind farms. Xcel and Ameren Corp. increased their earnings growth rates and "on the margin it was driven nearly entirely by renewable energy," Byrd said.

Morgan Stanley ranked the Southeast the second region by "transition potential" given its favorable solar economics.

The levelized cost of solar is expected to be as low as $30/MWh even after the step-down of investment tax credits, well below the average all-in cost of coal of $41/MWh in the region.

Morgan Stanley projected 21,000 MW of coal capacity to be at risk by 2030 under the base-case scenario, with about 57,000 MW at risk under a carbon-pricing scenario.

"What is interesting is, solar essentially flipped to become the cheapest resource in some Southern states about one to two years ago for the best states," Byrd said. "That is what is so interesting with NextEra and their large utility Florida Power & Light Co. They went from relatively modest solar additions to the largest solar program in the United States, and they waited until solar became really compelling."

Analysis flaws?

Morgan Stanley acknowledged, however, that it is challenging to predict utilities' decision-making behavior.

"It is honestly hard to predict how different utilities will evolve their generation mix over time," Byrd said.

It is also possible that potential locally driven hurdles to renewables deployment, such as land acquisition, and a more rapid growth of natural gas infrastructure could change the pace of coal retirements.

"On the other hand, we may be underestimating the growth in renewables," analysts wrote.

They highlighted the potential for greater federal regulations on coal-fired plants and natural gas pipelines as well as stronger resistance at the state level to building natural gas plants. It is also possible that natural gas prices rise if the government enacts stronger restrictions on fracking and the permitting of natural gas extraction on federal lands.

A change at the U.S. Environmental Protection Agency could mean a "more rigorous approach to regulation of coal-fired power plants," Byrd said.

"The big dynamic, but this would likely require a Democrat Senate as well as a Democrat president, would be carbon pricing," Byrd added. "That was one thing, I guess it surprised me a little bit, but when we ran the numbers even at a price of say, $20 a ton, that would cause [almost] every coal plant in our model to screen uneconomic."