Will it be NextEra’s Era?
NextEra Energy is one of the largest renewable energy utilities in the U.S. – the largest when it comes to wind and solar. This post discusses opportunities and threats posed by climate change, and how management has dealt with these thus far.
NextEra Energy (“NextEra”) is one of the largest renewable energy utilities in the U.S. – the largest when it comes to wind and solar. Its entire business model is based upon providing clean energy at low cost, and hence it is not unsurprising that climate change presents great opportunities for this company. However, the boon of climate change also presents some challenges to its existing business in the form of uncertain generation resources.
The first and most obvious benefit of climate change is increased demand for renewable energy. In the U.S., a large driver of this growth with be from companies that contract for renewable energy capacity directly through Corporate Renewable Portfolio Standards (“CRPS”) schemes. Currently only 3% of Fortune 500 companies have CRPS, as compared to 45% who have sustainability goals, indicating significant opportunities for growth. Companies are motivated to engages in CRPS for financial and non-financial reasons, key among which are for energy price certainty (fixing prices paid for electricity), tax benefits (30% of the cost of producing renewable energy), and marketing. These reasons have led companies such as Google, Amazon, and Walmart to contract for renewable energy.
NextEra’s management has been successful in securing demand from corporations. It is the market leader in providing CRPS power generation capacity with an 11% share[1], and has done this through being a first-mover into renewable energy and being strategic with its growth. Firstly, it discarded its non-power businesses (limestone quarries, telecommunications, and water utilities) in 1950 to become a dedicated power company, then became an early-adopter of wind energy in 1999, and then solar power in 2009, and eventually secured a deal with Google in 2010. These show that NextEra’s management has been effective in moving into new technologies and securing clients.
Increasing demand for renewable energy is also an international phenomenon, but NextEra’s management has not entered the global market. Going international has the benefits of diversifying risks (further discussed below), and gives NextEra the opportunity to gain returns above those seen in the U.S. Financial returns on renewable energy investments in the U.S. have declined over time as competition has increased and revenues increasingly regulated. A typical wind or solar project in the U.S. yields levered project returns of ~10%[2], whereas projects in international markets such as China and India (chosen specifically because these are the two largest carbon-emitting countries aside from the U.S.), can give higher levered returns due to improving regulation, market fragmentation, and availability of financing. Entering these markets does not come without additional risks, such as foreign exchange risks, regulatory risks, and other business risks, but I would argue that many of these risks can be mitigated if NextEra focused its growth on partnering with international companies that operate in these countries. For example, an international partner who is interested in adding solar panels to its manufacturing facilities in China would reduce land procurement risks and off-taker risk for NextEra. Hence, in my view, NextEra’s management has not been effective in exploring international ventures, and is missing out on a significant growth opportunity.
Climate change creates risk for NextEra as it depends on favorable weather conditions in a specific area to produce power. Furthermore, Florida, where NextEra has significant exposure to, is in significant risk of flooding[3]. In addition, a large part of its portfolio is based on wind energy which is highly variable. This large exposure to wind energy becomes increasingly risky as climate change takes hold. To manage this risk, NextEra should diversify its energy sources to include other less variable sources, such as gas or nuclear power or expand internationally[4]. International expansion has the benefit of diversifying weather risks, as climate change impacts different regions of the world differently[5]. If we consider these two risk mitigation strategies, management has not been effective. Firstly, NextEra has not expanded overseas. Secondly, management has not maintained a highly diversified portfolio of renewable sources. Between 2010 and 2015, NextEra has increased its concentration in wind from 19% to 59%, with the share of nuclear and gas power decreasing from 66% to 32%[6][7]. While there were probably sound profitability reasons for increasing wind exposure, the risks from climate change have increased.
In conclusion, I believe that NextEra is well placed to capitalize on the opportunities presented by climate change, and management could use these to continue growing while reducing risk to itself over the longer term.
(735 words)
[1] Jon Windham, Barclays Research, October 26, 2016
[2] Julien Dumoulin-Smith, UBS Securities, April 15, 2016
[3] Kate Gordon, “Risky Business: The Economic Risks of Climate Change in the United States,” The Risky Business Project, June 2014, p. 26, http://riskybusiness.org/site/assets/uploads/2015/09/RiskyBusiness_Report_WEB_09_08_14.pdf, accessed June 2016
[4] Jackie Jones, “Balancing Act: How Can We Deal with Variability”, November 10, 2011, http://www.renewableenergyworld.com/articles/print/volume-14/issue-6/solar-energy/balancing-act.html
[5] David Wheeler, Quantifying Vulnerability to Climate Change: Implications for Adaptation Assistance, Center for Global Development, January 24, 2011, http://www.cgdev.org/publication/quantifying-vulnerability-climate-change-implications-adaptation-assistance-working
[6] NextEra Energy 2015 Annual Report p.16
[7] NextEra Energy 2010 Annual Report p.4
Interesting post! Agree that the presence and general consensus on climate change will lead to organizations and governments implementing policies to address and mitigate the risks, which NextEra is well poised to take advantage of. NextEra has both clean energy generators, and functions as a distribution utility. I’d be interested in learning a bit more on how the physical manifestations will impact each aspect of NextEra’s business.
Thanks for this – NextEra are certainly an interesting company. Regarding your thoughts on an international expansion, I believe NextEra were very shaken by their experience in Spain where due to policy change, they took a very big loss on projects there – something like $300m – http://www.csp-world.com/news/20130508/00856/nextera-s-csp-plants-spain-lead-300-m-impairment-charge-after-new-regulatory. With electricity generation being a (necessarily) heavily regulated industry, asset owners have to be very aware of the political environment in which they operate and from what I hear, at the current time NextEra are just not prepared to expose themselves to markets where they don’t have a deep understanding. It’s also a function of the curse of their investor base, who are predominantly drawn to them because of the regulated returns of Florida Light and Power. With an expectation to make steady, constant returns, it must be hard for the management to consider more ‘risky’ ventures overseas. A shame though as I’d quite like to work for them internationally! Cheers
As a follow up to this comment, it seems that NextEra also stumbled politically in their effort to acquire Hawaiian Electric Industries [1]. You are suggesting that NextEra diversify into new markets. What advice would you give them on their approach to ensure they don’t face the same setbacks and potentially expensive breakup fees ($90 million in HEI’s case)? [2]
[1] Utility Dive. 2016. UPDATED: NextEra, Hawaiian Electric terminate merger after PUC rejection. [ONLINE] Available at: http://www.utilitydive.com/news/updated-nextera-hawaiian-electric-terminate-merger-after-puc-rejection/422316/. [Accessed 7 November 2016].
[2] The Wall Street Journal. 2016. NextEra, Hawaiian Electric Terminate Merger Bid. [ONLINE] Available at: http://www.wsj.com/articles/nextera-hawaiian-electric-terminate-merger-bid-1468838067. [Accessed 7 November 2016].
Interesting to learn more about an energy and utility company. It is exciting to see the shift in the industry towards renewable energy. Nuclear power used to hold a lot of promise but currently I do not think it is quite renewable. Especially given the increased efficiency in solar panels, nuclear fission will really have no place in our future. However, certainly optimistic that nuclear fusion still might be useful once it is miniaturized and the power generation can be sustained. Wind is variable, as well as solar. A combination of different sources plus mechanism for storage would reduce the overall variability. Do you know NextEra has done anything related to energy storage such as battery?
Very interesting read. I love how “Green” of a power generator NextEra is! Competitors have a long way to go to rival this level of sustainability. Regarding your proposal for the Company to expand internationally, I assume this entails buying or building renewable generating assets abroad to sell power to electric utilities abroad? One concern I have with this strategy is that given the highly regulated nature of this industry, how similar are the regulatory requirements in international markets to those in the US? Are there significant similarities that could be leveraged, or are significant additional resources needed to manage this front? I’d also be interested to know about other players in the field who may aready do this well.
Very interesting article, thanks for sharing! I really like NextGen’s green initiative, but I have always been wary of wind power’s impact on other environmentally important issues. Not only can it be an unreliable source of power like you outlined in your article, especially in the face of unpredictable shifts in weather patterns, but it can also decimate local bird and bat populations. Do you think the questionable benefits of wind energy justify its habit of killing significant portions of a local area’s wildlife? I think the problem will only compound if more wind mills are produced unless there are new innovations available or mitigating strategies.