It seems almost every day we wake up to Earth-shattering headlines. The funny thing is that lots of really significant news gets lost amidst all the "Big Headlines". A great example of this was the recent report that Xcel Energy, a major electric utility based in Minneapolis, MN, plans to become 100% carbon neutral by 2050, a mere three decades from now.
This is big news because Xcel is the first major electric utility to pledge to become 100% carbon neutral, and, moreover, to provide a specific date. Now 2050 is still three decades away, and a lot of greenhouse damage will occur in that time. The other significant thing Xcel said is that within 15 years, it will reduce 80% of the carbon emissions it had in 2005. As such, most of the reductions should come in the next 15 years.
Another reason this is important is because Xcel is the kind of company most environmentalists love to hate. It's a big company – actually a big company with three major operating divisions: Northern States Power, Public Service of Colorado, and Southwestern Public Service in Amarillo. Altogether, it has about 3.3 million electric customers and 1.8 million natural gas customers.
Let's focus on the greenhouse gas emissions of the company. On the positive side, it operates 27 hydro plants and two nuclear plants. Of course, many environmentalists will object to the environmental impact of hydro and nuclear, but at least in terms of greenhouse gases, these 29 plants don't spew anything into the air.
In the greenhouse gas department, however, Xcel presently operates 13 coal fired electric plants that generate a combined 7,697 megawatts of power. More than enough greenhouse gases!
Which brings me back to the "real news". Xcel's management isn't going to eliminate all these coal fired plants because they want to be nice guys, even though they probably are. They're going to do it because it will make good business sense. Oh, I'm sure, management is presently being criticized by environmentalists, and much of that criticism is quite justified, as the utility industry has a very long history of ignoring environmentalists.
Are they doing this because of stiffer regulations? Pretty unlikely, especially given the Trump Administration's efforts to make life easier for the coal industry.
Instead, it's because it's a smart business decision. So let's look specifically at why getting rid of all these coal plants is a very smart business decision.
It get's back to the number one job of the management of a company: make money for the shareholders. In the case of a publicly-owned company such as Xcel, that means figuring ways to maximize the stock price. With that in mind, let's consider how the decision to get rid of coal could help Xcel's managements drive up the company's share price.
Stock prices are influenced by three things: company fundamentals, technical factors, and market sentiment. Let's consider each. The important thing to realize is that of these three factors, the management of a company can only influence one of them: company fundamentals.
Market sentiment is really an overall collective assessment the investing world makes. It depends upon things such as expectations of what the Federal Reserve will do with interest rates; what overall government policy is doing; and things such as the balance of trade and what's happening in foreign markets.
The important thing to realize is that the management of a company can't do anything about market sentiment.
The same is true for technical factors. These include things such as the level of inflation, substitute products, and demographics. For example, imagine that someone creates a great way for everyone to generate their own power, so it isn't necessary to depend upon the electric utility? Pretty much outside the control of the utility company.
Which leaves just one thing that management can do to affect stock prices – company fundamentals – something very much within the control of management. The key things here are the present value of future earnings for the company, as well as what's referred to as "free cash flow".
The best way for management to increase the stock price is to focus on things that will increase the company's earnings and free cash flow. Generally speaking, that comes down to doing the following three things: 1) generate more revenue; 2) reduce costs; and/or 3) increase productivity.
Unlike other businesses, utilities cannot do a great deal about increasing the amount of "product" or "service" it sells. Instead, the typical utility must simply be prepared to produce the kilowatt hours and cubic feet of natural gas that customers demand. The only thing the utility can try to do is to increase the rates charged to customers. That, however, is subject to government regulation.
The management of the typical utility works very hard to convince regulators to increase the rates charged to customers. Of course, on the other side of the table are a whole bunch of interests trying to keep utility rates low. It's a classic political process, and management can to some extent influence stock price by pushing hard to increase utility rates.
That leaves two other ways for management to influence stock prices: reducing costs and increasing productivity.
Here's where the real news is. The cost of alternative energy has gone down so much that wind and solar are now amongst the lowest cost power sources. New wind and solar installations can generate kilowatt hours at a lower marginal rate than can coal and natural gas.
Which means that, other things being equal, the management of companies such as Xcel can make a higher profit/kilowatt hour generated by building wind and solar capacity than by coal and natural gas.
As wind and solar technology continue to improve, that differential is probably only going to increase. Not only that, it will increase to the extent that fossil fuel prices go up.
All you have to do is have some supply disruption of oil and natural gas to have the prices of those fuels go up. Same thing for coal. In the case of coal, regulation could increase the cost of the input.
Utility plants typically have a 30 to 40 year lifespan, so when management contemplates building one, it has to consider not only current costs but the cost of operation over that lifespan. Doubtless, at the present time, the management of Xcel projects that over the next 30 to 40 years, the cost of operating a coal plant can do nothing but increase. Technology isn't likely to reduce the cost of generation. Conversely, the cost of a wind or solar facility has a good chance of continuing to go down over the same time period.
Which means that if the company wants to increase earnings and free cash flow, the better choice will be a zero carbon facility. If it makes that choice, other things being equal, there's a better chance the stock price will go up.
So if that's the case, why not just ditch all of the coal plants right now? Two likely reasons. One is that management believes it lacks the capital and the management time to make such a transition more quickly.
It would have to borrow too much money and couldn't afford the debt service. That problem could be overcome, especially if government regulators provide some type of relief to the company.
However, even if management could swap out all those plants, there is still the problem of spreading management too thin. Building a whole bunch of new plants would tax any organization.
There is a possible way around this problem. That's to have the company purchase alternative energy from a third party and just ditch all of the coal plants. If management could find alternative sources of power and purchase it, it could shut down all of those coal plants more quickly. If it could purchase enough clean power at a low enough price, it would make sense to shut all of the coal plants down as quickly as possible. There are, of course, some important caveats to doing this, but it could make good sense.
Of course, shutting down all those plants might create other problems. The most likely would be the economic impact in the towns where the coal plants are located.
This points the way to another great economic opportunity. Third parties could build new wind and solar plants that would provide clean power at a lower cost than the old coal plants. Xcel's management probably realizes this.
So why not just get third parties to build all of this new zero emission capacity and get rid of all of the coal plants? The short answer may be that government regulation has incentivized utilities to keep operating greenhouse gas polluting coal plants. We'll consider that in the future.
In the meantime, Xcel's management, in my mind, is making a brilliant business decision. I expect other companies will reach the same conclusion, and start doing the same. Which reinforces the idea that if you really want to get rid of greenhouse gases, the best way is through economics and better technology, not politics and regulation.
