Few utility companies are more convinced of the power of shale gas than Southern Co. But when the polar vortex hit last winter, the Atlanta-based utility, its 4 million customers in a four-state territory, along with utility investors got an object lesson in the limitations of the shale revolution.
As temperatures in Atlanta plunged as low as 6 degrees (F), the spot price of natural gas in various parts of the country climbed well above its recent price range. Prices spiked 40 percent on futures markets to as high as $8 per million British thermal units of energy (BTU)—up from a $4 to $5 range last fall. As the nation shivered (frozen gas pipelines were part of the problem), executives in Southern's Atlanta dispatch center fired up more coal plants.
"On those days, you run the plants you have available, from the cheapest to the most expensive, said John Trawick, Southern's senior vice president for commercial operations. "We were able to save customers $100 million because we were able to ramp the percentage of gas production down.''
As utilities and their customers move into a future in which shale gas is nearly ubiquitous, no utility exemplifies better than Southern the mix of aggression and apprehension the U.S. energy boom is causing. A decade after shale went commercial, the price of natural gas is much lower—it even dipped below $2 per million BTUs in 2012 during a market glut. But it's still too volatile to count on, and the need to upgrade or replace older, dirtier electricity plants—many of which burn coal—is offsetting much, if not all, of the savings from cheaper fuel.
The Environmental Protection Agency is expected to introduce carbon rules to cut down on emissions from U.S power plants on June 2.
"Natural gas being low is a key driver, but not the only driver,'' said Ali Agha, utilities analyst at SunTrust Robinson Humphrey in Atlanta, discussing the switch from reliance on coal to natural gas.
For investors, the shale rush has been a mixed bag. Utilities don't typically benefit directly from lower fuel costs, which are passed through to consumers as lower rates. And the industry remains challenged by another long-term energy trend: Greater efficiency of nearly all appliances means U.S. demand for power is expected to grow at only 0.8 percent a year through 2040, according to Energy Department forecasts.
Utilities—stocks favored by the proverbial "widows and orphans" for their reliable nature and dividend payments—tend to favor stability over growth. Southern is as good an example as any of how that institutional psychology is reshaping itself to include shale economics. Even as it builds gas-fired electricity plants and plans to retire coal-burning plants, the Atlanta-based utility is hedging its bets.
No utility in America is spending more on coal than the $5.3 billion Southern is pouring into the Kemper coal-gasification plant in Mississippi, whose cost overruns have hurt profits and the stock price of the fourth-largest U.S. utility company in the past year. Its shares are down more than 7 percent in the past year versus the Utilities SPDR return of 4 percent. Year-to-date, Southern shares are up 5 percent, but utilities stocks have raced ahead, with the index doubling Southern's return, up 10 percent.
As well, no utility in America is making a bigger commitment to new nuclear power than the $4.8 billion Southern and its partners are spending to add two reactors to the Vogtle nuclear power plant in Waynesboro, Georgia. (Southern owns 45.7 percent of Vogtle). The two nuclear facilities are set to open in 2017 and 2018.
Utility executives still don't trust that the drop in prices for historically volatile natural gas is permanent, said Richard McMahon, vice president of energy supply and finance at the Edison Electric Institute, a utility trade group in Washington. A dozen years after the late George Mitchell—the wildcatter, not the former senator—commercialized hydraulic fracking, the industry is still determined to keep its energy sources diversified, McMahon said.
"Customers want affordable, environmentally safe electrical power, and the way to do that is with a mix of fuels,'' McMahon said.
The trend toward more use of natural gas—and less coal—is real, and it is nationwide. In 2004, utilities generated 50 percent of power using coal and 18 percent using gas, according to the U.S. Energy Information Administration. The rest is mostly nuclear and hydropower, with some solar and wind energy thrown in. Now that mix is 39 percent coal and 27 percent gas.
Southern is among the utilities driving to switch more plants to natural gas. Southern now gets 45 percent of its electricity from gas, up from 16 percent in 2007. Coal use is down to 41 percent from 70 percent. But between now and 2020, the biggest change in its portfolio will be a doubling of the share from nuclear power, Trawick said.
In Georgia new nuclear plants will add 2,200 megawatts of power—planned solar and renewable generation will add another 800 megawatts. In Mississippi the Kemper plant will depend on lignite coal, which is readily available in the area around the plant.
"If gas goes back up to $12 [per million BTUs], they can crank up the coal plants," Agha said.
A 2013 report by IHS Global Insight estimated the average household reaped $1,200 from new shale usage in 2012, including lower utility bills and other benefits. The shift to shale may have helped stabilize utility bills, but it may not end up being the consumer bonanza the industry often claims.
The reason is related to utilities that are regulated in states with more traditional regulatory schemes, like Southern's base in Georgia, Alabama, Mississippi and part of Florida. Stripped to essentials, the average electric bill is broken into two parts: a fuel charge that is passed through to consumers with little or no markup, and a cost for building and operating power plants and lines, which is where utilities generate profits that make their way to shareholders in the form of dividends.
For customers, fuel charges are dropping, but charges for the new plants cancel out most of the fuel savings, said Morningstar utility analyst Mark Barnett. At the same time, investors will see utilities' revenues rise, but not by much, he said.
Southern's Georgia footprint is a good example of the tension between utility bill savings and capital investment. Southern cut rates by an average of $8 per month for residential customers in 2012, but rates rose 2 percent this January to reflect the beginning of paying for new plants. On top of that, the Vogtle plants have already added about 4 percent to bills to pay for interim financing costs, and another 2 percent to 4 percent will be added when the two reactors open, according to testimony before the state's Public Service Commission (PSC) in April. For the average Georgia Power residential customer, that may mean a little more than $7 a month, according to a calculator on the PSC website.
"Economically, it's probably a wash,'' said Charles Acquard, executive director of the National Associations of State Utility Consumer Advocates, which represents consumer interests before state regulators.
Returns for Southern's shareholders from the shift to shale have also been mixed, primarily due to recent problems at Kemper. The company took a $235 million after-tax charge in the first quarter because of cost overruns, on top of $333 million of charges last year. An estimated $1.6 billion of cost overruns at Kemper can't be passed on to rate payers, cutting into shareholder returns, Barnett said.
The longer-term challenge for all utilities, including Southern, is the modest growth in electricity demand. For investors, this means the shale revolution won't change as much as casual observers might assume. Any business with demand growth so low—less than half the rate of economic growth in general—will continue to rely on milking existing businesses for efficiency and aim for dependable if modest returns.
This is a formula utilities are used to—having used high dividends as the bulwark of shareholder returns for years. At Southern the $2.10 per share annual dividend works out to a 4.8 percent annual yield at current prices. Jefferies analyst Anthony Crowdell expects shares to return about 8 percent to 9 percent over the next year, including the dividend.
That calculation shows that shale doesn't change what has always been true about investing in utilities: "Utilities are never growth stocks," Barnett said. Not even rapid shale resource base growth seems poised to change that law of the utilities market.