As the world commits to reaching net-zero climate targets by 2050, electrification will play a key role in that transition. Greg Bonnell speaks with Marisa Jones, Utilities Credit Analyst at TD Asset Management, about the opportunities for the utilities sector on the path to net zero.
- If the world is serious about meeting net zero climate targets by 2050, then electrification will be key. So what opportunities does that present for investors interested in the utility space? Joining us now to discuss is Marisa Jones, utilities credit analyst with TD Asset Management. Marisa, great to have you with us, and a really fascinating topic too. If we talk about electrification in the future of everything, what does that actually mean for the utility space?
- Great, thank you for having me here today. Yes, it's a very exciting time I think to be following the electric utilities. When I started my career back 20 years ago or so in fixed income, utilities were a boring sector largely. And that's great for fixed income. As a credit analyst it's good to have a sector that's very reliable and transparent, and you can predict what their revenues will be.
But since that time, there have been a lot of changes. I'd still say one of the qualities of the electric sector is that it is still very stable and reliable. But I think especially now facing this energy transition globally and in North America, the regulated electric utilities have a lot of growth ahead of them.
So I'd like to sort of focus both on the growth ahead of it as an opportunity for investors, as well as the specific role that utilities power, as well as transmission and distribution, play in the energy transition. So on the growth side alone, aside from the fact that we expect huge population growth globally, I think what you're seeing, particularly in North America, is that growth for the utilities will be outsized, meaning outsizing economic growth alone or population growth. And by that what I'm looking at is you have factors such as technology growth, so here I'm looking at data center use for power, and also the specific role utilities have in the transition. In that they have to be able to adapt to climate change, become more resilient, harden the grid they call it. Plus there's huge role for power in particular, so this is the generation side of utilities, to green the grid.
So yes, you want to have companies and households reducing their emissions, but you can only do that if you have the electricity that's flowing into their houses, and hopefully into electric vehicles going forward, that power has to be green as well. So I see a lot of upside in terms of growth, and with that comes a lot of spending.
- I was going to say, is the grid, is our power generation as it currently is, up to the job? Because when people talk about say electric vehicles, they say if you're going to meet these targets, then you got to electrify things. You got to electrify the vehicle fleet. But if everyone suddenly overnight in this country had an electric car plugged into their house, it raises the question, are we even up for that challenge at the moment?
- Yeah, and a very good question. It's interesting because we're moving more quickly towards EVs than I think was expected even five years ago. And I think this is a positive trend going forward, but yes, are we prepared? I think what is in the favor of utilities and for us as a society is that we have time.
So for example, other jurisdictions, you're looking at Europe and China, are well ahead of us in terms of-- us meaning North America, US, and Canada-- in terms of adopting electric vehicles. So first of all, we can learn from mistakes made in other countries, that's number one. Number two is that we do have time.
So for example, the cost curves of EVs have come down. And there are estimates that show that the cost of an electric vehicle will be on par or reach parity with combustion engines as early as 2025 in most regions. So with that you're seeing a shift in demand. It's not just policy driving adoption of electric vehicles. Now, you're actually seeing drivers wanting to drive them, and you're seeing this demand pull, so that's a good thing.
But adoption is still going to take time, because you have to produce these electric vehicles. And then the other factor is even if the actual sales continues to increase at the pace it is, we have time before-- cars last, an average combustion energy vehicle might last 10 years. So you're not going to see those being phased out as quickly as you're seeing the sales pick up. So that's number one, we do have time.
But we're already investing in this. So in Ontario you're seeing partnerships, and these go back a number of years, where Hydro One and OPG, Ontario Power Generation, for example, have partnered to create something called the IV charging system, and they're rolling this out. In fact, I think I just saw a press release yesterday that they've added these fast charging stations to I think 16 more on routes.
- That's key, too. If you're going to get an electric vehicle, you're going to hit the road, I mean, it's summertime, you take the road trip. You got to make sure you can get some juice into that thing.
- Yeah, and it reduces range anxiety. So that's something that will make demand continue to increase. So but my point is that we're already investing, but it's not just by the utilities themselves. There is support. So that program I just mentioned has some federal government support in it.
So we're seeing that, because the policy initiatives are pushing us this way as well. So there's an alignment between what the utilities want to do, hopefully what driving demand or consumers. So it's not just EVs. We're talking about electrifying heating pumps and other ways to reduce emissions globally, and we're moving towards that trend. And policy is pushing it that way, too.
So I think there's a good balance there. There still might be hiccups, but I'm seeing that we're going to reach these milestones because everything is aligned that way.
- Obviously, the push in that direction for electrification is about trying to meet those commitments we've made for the environment and the emissions targets. You talked a second ago you mentioned about hardening the grid.
MARISA JONES: Yes.
- Because as we move in this direction to try to lessen the effects of climate change, we're seeing some pretty intense weather. That sounds like an expensive proposition to harden the grid.
- Yes, so that specific terminology refers to things such as in zones where there might be flooding, or hurricanes in the US, you're burying the cables, and that's very expensive. Or they might be putting in transmission towers that are more resilient so they're not going to be-- ice storms should not be taking them down as easily. So there's a lot of money going into this.
So again, for the regulated utilities as well as the unregulated power segment, there's been this need and it's been seen for a while. Because climate change has been impacting all the physical aspects of the grid for a while now. So this investment has been picking up.
And indeed, 2021 was a peak year for CapEx for the utilities in the US, and it's not expected to come down. So that spending will continue. And with that spending, again, this is why I'm saying you're going to see outsized growth in utilities. Outsized so you have a stable regulated sector for the most part, yet there's growth behind it. So I think that's why it's interesting both from my perspective, from a debt perspective, as well as some equity investors. Because you can see it's reliable cash flow, but supported by growth.
- I was thinking when you talked about having to harden the grid and all the expansion needed to make, it's probably going to be some debt issuance there, isn't there, to try to pay for this all. So from the investment point of view then suddenly saying oh, then this could be a very active space.
- Well, and regulated utilities, the one interesting perspective or maybe exciting from my perspective is, as a bond analyst, when they issue-- they have a CapEx program-- it's largely derisked. And by that I mean unlike other corporations not regulated, CapEx is largely assessed by the regulator ahead of time. This is deemed necessary, it's deemed prudent.
There's a lot of derisking for that CapEx. So again, it's a fairly stable industry. But about 50% or 60% of that funding will be in the form of debt issuance.
So when I'm looking at the corporate bond market, we want liquidity. So one of the aspects that affects pricing of bonds is if there's not a lot of liquidity within a curve of an issuer, it might trade either more expensive than it should otherwise or just not trade at all. So I want that liquidity.
So there's balance between having too much issuance, which might push spreads wider or make the bonds cheaper, or not having enough liquidity. So I see if you have predictable issuance needs, it helps the market with liquidity. And it helps our job as fixed income investors.