The Inflation Reduction Act recently passed by Congress adds significant long-term certainty for electric utilities and power generators eager to transition to cleaner power sources, but the effects won't be felt for a few years. That doesn't mean industry is waiting around in the meantime.
In an astonishing trend, the United States added 462% more electricity from renewables than fossil fuels in the first half of 2022 compared to 2021, according to the U.S. Energy Information Administration (EIA). Renewable energy accounted for 25.3% of the nation's electricity generation in the first six months of this year, a full three percentage points above where things stood at the halfway mark of last year.
Simply put, the energy transition is an unstoppable force. Investors may want to hop on board if they haven't already.
What's Driving the Energy Transition?
Investors can think of the energy transition in the power sector, meaning the electric grid, occurring over three phases.
The first phase of the energy transition was powered by the rise of onshore wind farms, the decline of coal-fired power plants, and the rapid buildout of natural gas-fired facilities to plug in the gaps.
From 2007 to 2021, the United States experienced virtually no change in total electricity generation, but the nation's energy mix underwent historic changes.
- Coal-fired power plants fell from 48.6% of national electricity production to just 21.6%.
- Natural gas increased from just 21.6% to 37.8% in that span.
- Meanwhile, total renewables jumped from 8.5% of the energy mix to 21%.
Here's another way to look at it: The United States lost 1,117 terawatt-hours (TWh) of electricity generation from coal between 2007 and 2021. That was replaced by 678 TWh of new gas-fired generation and 505 TWh of wind and solar generation.
The second phase of the energy transition – now underway – is being powered by similar trends, although the rise of utility-scale solar farms and peaking reliance on natural gas are becoming more important factors in the energy mix.
In the last three years or so, utilities and power generators raced to build onshore wind farms and utility-scale solar farms before tax credits expired or became less valuable. That led to a surge in new production capacity in 2021 and 2022.
Consider the historic changes from June 2020 to June 2022.
- The United States grew installed capacity of utility-scale solar from 38.8 gigawatts (GW) to 63.3 GW, an increase of 63%.
- The United States grew installed capacity of onshore wind from 107 GW to 137 GW, an increase of 28%.
Many renewable power plants added in 2021 are contributing to energy production for the first time in 2022 – and they're making their presence felt.
From the first half of 2021 to the first half of 2022:
- The United States added 22.3 TWh of electricity from solar (including small-scale installations) and 47.7 TWh from wind.
- By comparison, the nation added only 39.7 TWh from natural gas and saw coal-fired power generation decline by 27 TWh.
- In total, the United States added 82 TWh from all renewables and only 14.6 TWh from all fossil fuel sources.
This is a remarkable shift compared to the first phase of the energy transition when natural gas-fired power plants were responsible for most new generation.
Here's another way to look at it: The United States could add over 90 TWh of electricity from wind power and 35 TWh from solar in 2022 compared to 2021. That nation only added 345 TWh and 160 TWh from wind and solar, respectively, in the 14 years spanning 2007 to 2021.
The trend will accelerate in the next few years. The EIA estimates 13 GW of solar was added to the grid in 2021, but expects another 44 GW to come online by 2023. Why is that important?
Whereas wind power production peaks in early spring and early fall, solar production peaks in summer. That sounds obvious, but national energy consumption also peaks in summer due largely to air conditioning. That makes solar uniquely positioned to help renewables continue dominating the energy mix and put the final nail in the coffin of coal-fired power plants.
The third phase of the energy transmission beginning near 2030 will be powered by all the same trends, although offshore wind power will begin to nudge natural gas-fired power plants off the grid.
Nearly 30 GW of offshore wind capacity is expected to come online by 2030, up from virtually nothing today. That may not sound like much, but these next-generation power plants can produce two- and three-times as much electricity per GW than onshore wind and utility-scale solar, respectively. They will also generate electricity for the country's major coastal population centers, helping cities rapidly reduce their reliance on coal and natural gas facilities.
How to Gain Exposure to the Energy Transition
Let your individual investing style, preferences, and goals guide how to gain exposure to the energy transition in the power sector. There is no shortage of options.
- The most stable energy stocks will be electric utilities such as Xcel Energy (XEL). It pays a generous dividend yielding 2.6% and boasts some of the world's best geography for wind and solar farms. The utility leaned on renewables for 36% of its energy mix in 2021, which is expected to climb to 53% in 2025 and 67% in 2030. All milestones would be well ahead of the national average.
- Solar manufacturers have never been reliable investments due to the complexities of international trade. However, First Solar (FSLR) may boast advantages thanks to its healthy balance sheet and focus on American-based manufacturing. If it can turn the benefits of the Inflation Reduction Act into durable advantages, then it could buck the industry's historic trend of terrible long-term stock performance.
- Every time investors think Enphase Energy (ENPH) is overvalued it keeps powering higher. The stock is likely a little stretched, but the company's leadership position in microinverters (important hardware in solar systems) and its North American supply chain could provide long-term advantages. Keep in mind the business is valued at over 13 times 2023 revenue expectations and faces a fierce competitive landscape, which is likely to eat away at margins over time.
- Stumbling industrial conglomerate General Electric (GE) has been an important provider of both wind and gas turbines through the first phase of the energy transition. That will remain the case for the foreseeable future, albeit with a bit of rebranding. General Electric plans to spin off its energy business in early 2024, which, pending the details, could be worth a closer look. The business generated $34 billion in full-year 2020 revenue and boasts offshore wind, solar, and next-generation nuclear ambitions.
