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Security selection is essential in determining which companies are best positioned to profit in the "green age" of renewables.

Fifty years ago, a person’s day may have included watching the nightly news on the television while listening to a favorite station on the radio. Fast forward to the present: This same person might instead be reading the latest breaking news while simultaneously listening to a song on a smartphone. While the media devices have changed dramatically over the past fifty years, what hasn’t changed is the fact that the person still requires energy to power his or her life. What has changed is how that energy is being sourced and generated by the local utility company.

For more than a century, fossil fuels dominated energy usage, with coal and natural gas as the primary generation sources. However, as fossil fuels have fallen out of favor, interest in renewable energy has increased meaningfully, with substantial growth anticipated for solar and wind energy. For evidence, we need to look no further than comparing Exxon Mobil, a leader in fossil fuels, to NextEra Energy, a leader in renewable energy. A decade ago, Exxon Mobil was the largest company in the S&P 500 Index with a market capitalization of $318 billion, while NextEra Energy was valued at $23 billion, less than 10% of Exxon. Today, the companies are nearly identical in market cap at around $140 billion. Investors need to understand that an energy transition is underway and that not all utility companies are equal with respect to renewable energy.

Innovation in energy is not a new phenomenon as evidenced by the evolution of energy sources in the history of the United States. When the country was founded in the late 18th century, burning wood and capturing flowing water — each of which is a renewable energy source — were the primary means of producing energy. These forms of energy persisted until the 19th century when the industrial revolution introduced burning coal as the new primary method of generating energy, thus ushering in the era of fossil fuels.

By the turn of the 20th century, oil and gas were found to be easier to utilize than coal for many energy applications, which resulted in the soaring usage of fossil fuels. After World War II, nuclear was introduced as yet another form of energy; while this energy source is considered carbon free, nuclear is not considered renewable, however. This evolution in energy has not ceased in the 21st century. Renewable sources of energy have re-emerged this time through developments in solar and wind energy, with both sources quickly gaining favor across the country.

Understanding why renewable energy sources such as solar and wind have rapidly become more popular is not difficult. Environmental benefits include reducing greenhouse gas emissions and air pollution while economic benefits include reducing dependence on imported fuels and creating economic development opportunities. These benefits have not been lost on state governments: Over thirty states have passed legislation to encourage utility companies to retire fossil fuel plants and replace them with renewable generation sources. Target dates must be met to maintain compliance with the laws.

In addition to state mandates promoting renewables, many renewable energy sources are benefitting from continued technological advancements that have culminated in price competitiveness with fossil fuels even without government incentives. This is significant because the lower cost allows the utility company to generate renewable energy without burdening the consumer financially, which appeases state regulators. Ultimately, the utility company benefits from new renewable investments through an increased rate base and the potential for higher profits while the consumer benefits from a cleaner environment at a still-affordable price point.

Due to the factors mentioned above, renewable generation has begun to rapidly replace traditional fossil fuel generation. The US Energy Information Administration (EIA) is now forecasting that renewable sources will comprise the plurality of generation by 2050. While these are projections, the underlying data derived from upcoming utility investments supports this outlook. In the next five years, solar and wind generation are expected to increase 139% and 38%, respectively, whereas coal generation is scheduled to decline by 15%. The trends clearly favor renewable energy, with both solar and wind expected to be the growth leaders in power generation over the next thirty years.

Many utility companies have initiated investments in renewable energy projects to take advantage of growth opportunities and meet the state law mandates. However, investors need to understand that not all utility companies are equal in this respect. The utility companies that are proactively investing in renewable energy or that operate in states with renewable energy mandates are better positioned than utility companies that remain focused on the fossil fuel business or operate in states without renewable energy mandates. Security selection should be a key focus due to the expanding market preference for utility companies that have a strong renewable/ESG (environmental, social, governance) profile and the outperformance associated with these companies. As the ESG market develops further, this preference has the potential to accelerate in the future.

While the world of energy continues to innovate, investors would be prudent to take notice of these trends and adjust their portfolios accordingly. As renewable energy ascends and fossil fuels wane, investors need to recognize that companies will vary in their response to the energy transition. Security selection is essential, and the team at Key Private Bank is keenly aware of which utility companies are best positioned to profit in the "green age" of renewables.

For more information, please contact your Key Private Bank Advisor.

Publish Date: October 12, 2020.

Any opinions, projections, or recommendations contained herein are subject to change without notice and are not intended as individual investment advice.

This material is presented for informational purposes only and should not be construed as individual tax or financial advice.

KeyBank does not provide legal advice.

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