NextEra Energy: Both Halves Of The Company Face Risk In New Florida Regulations
Summary:
- NextEra Energy and NextEra Energy Partners are effectively one company, despite their separate tickers, given the extent of their financial interdependence.
- NextEra Energy is potentially threatened once again by regulatory changes which could induce large-scale grid defection in Florida, after such changes were thought to have been abandoned.
- The creation of any significant pricing differential in solar power production and consumption for households drives residential to batteries, which can induce complete defection from the grid.
- NextEra relies on Florida utilities for the preponderance of its operating income. Renewables remain a lucrative but secondary income source.
- Because significant grid defection in Florida could threaten NEE’s main income source, I am avoiding the companies despite recent operational improvements.
Almost three years ago, I took my first look at NextEra Energy (NYSE:NEE) and NextEra’s affiliate NextEra Energy Partners (NYSE:NEP) because it looked like, just perhaps, some history was about to be made in both Florida and the American electricity market in general.
I haven’t returned to the subject since, and recently received some queries about “whatever happened” with the rather unique thesis I laid out for American utility stocks in the spring of 2022. With 2024 about to draw to a close and a new administration about to take office and shake up American energy policy (again) I wanted to take a fresh look and provide an update.
Author History
My most recent article 30 months ago covered NextEra’s earnings report, which I found on the whole to be strong, if a little qualified in its strength. NextEra had encountered a number of bumps, not least to its Mountain Valley Pipeline, but on the whole, it seemed primed to continue to develop a strong pipeline of renewable energy projects.
In order to have considerable upside beyond its current trading price; however, NextEra also needs to preserve the profit stream it already has as its new, renewable profit stream comes online. The existing profit base stems largely from Florida Power & Light, one of the main utilities in the state of Florida. As I explained in my first article on the company, that profit stream was more under threat than ever before.
My articles on NextEra have actually held up reasonably well. As of this writing, the stock I cautioned to avoid is trading 6.5% lower than it was at the time of publication – while the S&P is up 43.5% over the same period. NextEra Energy Partners has done even worse, down a staggering 75% since my initial article.
NextEra Energy Partners’ Steep Decline
Before everyone jumps all over me, I am well aware that the reasons NextEra and Partners are down have little to do with my original thesis. In addition to the issues affecting all utilities right now – roughly 500 basis points of Fed rate hikes in a little over 18 months – the other major source of value loss was when NextEra fell by approximately 25% at the end of September 2023, largely because its mega subsidiary NEP fell by over half over the same time frame. The cause was a substantial retrenchment in NEP’s growth projections and therefore, its projected distributions to its shareholders, principally NEE.
Since then, NEE has bounced (mostly) back as rate hikes came to an end and even began to swing into reverse, although now it’s being questioned just how far those cuts will go. Partners has not been so fortunate. After falling by half to $23 in a week, it had only rallied to a meager $25 by this past October, when it fell 15% following Q3 earnings and continued to fall all the way to $16 by mid-November. It now tenuously holds at $18.
Much of the analysts examining NextEra in the last few years have concentrated on the impacts of rate hikes, the economic viability of NextEra’s considerable renewable energy portfolio, and of course, just the ongoing cost of energy and providing power. I agree these are all important considerations, but I can’t add much to what has already been written on these topics.
The Hidden Risk
Nevertheless, I continue to believe that one of the issues that is not being given sufficient attention as the focus has shifted to other matters is the potential, at some point, for a large-scale embrace of grid defection by a growing segment of the population. As I’ve argued before, the fact that close to half of our electricity costs are fixed costs, irrespective of the amount of energy passing over the grid, means that
Essentially, the electric grid could find itself confronted by the same issues that have plagued the cable television industry. The cable TV industry’s decline was relatively slow, owing to its relatively low amount of fixed costs, since the biggest TV cost category is content costs, which go down as fewer subscribers are on the service. But the grid’s fixed costs are much higher, which means that if a snowball effect begins to take shape, in the form of grid defection, it will roll down the hill to its final destination much faster once it gets going.
Such things are more likely to hit NextEra, Inc. than Partners, which does not hold large-scale traditional utility operations. I am not convinced the two are so easily separated, however. NextEra owns roughly 52% of the operating company which it shares with Partners, with NEP owning the remainder. NEP finances are so interconnected with NEE that it is unlikely that material financial stress in the latter could be prevented from infecting the former. NEP relies on NEE for loans, management services, and even allows NEE to withdraw funds from its own operations as needed. The two should therefore be considered together as two halves of one whole.
Fate Of The 2022 Proposal
It was these considerations that first prompted me to get into the story of this company. NextEra spent most of 2021 lobbying intensely for some of the most sweeping changes to net metering laws since they were enacted. After vociferous debate they passed the Florida legislature in March 2022, prompting my first article expressing concern about NextEra, and all that was left was for the governor to sign the bill.
When NextEra’s earnings report came out a month later, the bill was still pending. Ordinarily in Florida, bills are signed or vetoed within seven days. It went differently here, I guess, due to the legislature’s recess? But nothing indicated there was any change in plan, so I remained neutral on NextEra despite an earnings report I considered more than adequate. More than half of NextEra’s operating profit remains FPL-based, so since I wasn’t convinced those profits were safe, I wasn’t convinced an investment was wise.
Then came the bombshell. Shortly after my second article, the governor announced that he had vetoed the net metering bill. This seemed to me such a low probability event, I hadn’t even discussed any odds or discount percentage for it in my original articles. Before everyone says how sloppy that was of me, let me offer just one defense: this shocked everyone. No, not surprised, shocked. And not some people, just about everyone.
The environmentalists who led the opposition called it a “huge surprise.” When the news media went to the bill’s lead sponsor for comment, they reported he’d been “caught flat-footed.” The bill was a slap in the face to NextEra and other large state utilities, among the most generous political contributors in the state. No one saw this coming.
Fixed Solar Fees Go Out With A Whimper
Frankly, I never even considered the possibility of the changes not happening because, like everyone else, I saw absolutely no indication that DeSantis was even thinking about not signing. In my first article, I wrote that “the bill received final approval from the state legislature last week and now goes to the governor.” I didn’t write “who will sign it into law,” but only because I considered that utterly superfluous. A veto never even crossed my mind.
But suddenly, a looming tidal wave of regulatory changes that could have fundamentally altered consumer relationship with the electric grid seemed to have gone out with a whimper, instead of a bang. California’s fixed fee proposals also flagged quickly, perhaps thanks in part to Elon Musk, who not only offered sharp criticism of the bill himself, but even publicly enlisted his California employees to mobilize against it.
Not that Musk’s opposition was necessarily the decisive factor; the proposal was getting savaged by the environmental movement – very strong in California – even before Musk started lobbying. It is now on hold “until further notice.” Although the rest of California’s Net Metering changes went effective in April 2023 without the fixed fee component.
Utilities Scaled-Down New Effort
The Florida media was ablaze with theories about what went wrong with FPL’s powerful lobbying machine. The leading theories are that DeSantis didn’t want to fight Disney and solar owners at the same time, since he was already engaged in a major showdown with the former over the “don’t say gay” bill and the retaliation against Disney’s park district. Other theories are that he was upset FPL had lowered its contributions, or just that he never supported the bill but refrained from speaking against a powerful lobby in case the legislature decided to get him off the hook on its own. Or maybe the considerable public outcry really did force a change in course. But for our purposes, it doesn’t really matter.
What matters much more is that after two years, FPL is finally ready to try again, or at least others are trying to enact pieces of what FPL wants. Though, it’s likely to look a little bit different. After the backlash in 2022, everyone agreed the next version would omit the fixed fee solar portion of the changes.
As it turns out, the latest proposal is out of the Orlando rate commission, not statewide as of yet. A trial balloon, of sorts. The proposal now is for a smaller fixed fee of $5-$15, to be applied to all households, not just solar households. This is far lower than the $8 per kWh that was in the 2022 bill. But, the much lower fees were officially approved today by the Orlando commission. Unlike the 2022 bill, this one is definitely going into effect.
The New Solar Poison Pill
And yet this one also ignited fierce backlash and has already been watered down twice. The reason is that while fixed fees will not be charged, the proposal will still drastically throttle back the rate at which excess solar power, which is exported to the grid, will be credited to customers’ accounts.
Usually, power is credited kWh for kWh; if you export 50 kWh in the daytime, the utility won’t charge you for the first 50 kWh you consume at nighttime. Going forward, however, Orlando utilities will purchase solar at the fuel rate, i.e., about 40% of the total per-kWh charge, and still charge households full price for all incoming energy.
The more things change, the more they stay the same. Residents have risen up against this “stealing” of “their” energy, and I can understand why, but far more interesting that utilities continue to assume that if they undertake this sort of bifurcated rate schedule, residents will not adopt the single most obvious solution to the problem: don’t send your excess energy back to the grid. Keep it for yourself. And put it in a battery.
Batteries Rise As Alternative
Only a few years ago, I would get all sorts of nasty comments for daring to suggest that batteries posed a real threat, as opposed to opportunity, for the grid. This is because typically energy analysts have thought of batteries as something the grid itself controls.
Witness the proposals that PG&E (PCG) would close some of its power plants and replace them with electric battery storage. As early as 2016, the State of Minnesota was actually projecting that it would soon be cheaper to build massive lithium-ion battery farms than natural gas peaker plants for balancing load on the electric grid. Also, batteries in car drives demand for electricity, and therefore the grid that provides it.
My belief, however, has long been that batteries threaten the grid at least as much as they support it because batteries are the first alternative in 150 years to the service the grid provides. Namely, the generation of all-day electricity that does not depend on a single power source for energy. Historically, the only way to keep the lights on day and night was to hook up to the grid and pay whatever fees the grid demanded. This was an incredibly lucrative monopoly that generated massive, outsized profits.
No longer. It is now feasible to buy a battery and a solar panel for your home, and simply not use the grid at all.
Grid Defection Counter-Strategies
In the last decade, utilities have largely seen off the threat of wide-scale grid defection in two ways. First, they have threatened potential defectors with prosecution, under vague but powerful laws that as interpreted by many local authorities mandate that all households be connected to the grid and pay grid fees.
The other, however, is that they have largely forborne to enact pricing policies like the one in Orlando. People in solar homes have not felt any great urge to leave the grid because the grid gives them full credit for every kWh of extra power they send. Essentially, the grid acts exactly like a battery would act, soaking up excess power and returning it in full later.
Now, however, the Orlando utilities will essentially impose a roughly 60% haircut on excess solar power. For every 10 kWh you send them, they send you 4 back. Any sensible person who had a battery that leaked 60% of its energy would quickly conclude that they needed to replace the battery. In this case, replace the grid with an actual battery.
Legal Risks Receding
The economics of batteries having just been made overwhelming in Orlando, the only way to see off the threat now is the other prong of the anti-defection strategy: prosecution. I based my initial thesis two years ago on the idea that such prosecutions were highly unlikely to work at scale once a large-scale price differential in the export/import of solar emerged.
Politically, throwing people in jail for wanting to leave a grid that’s ripping them off just won’t fly. The pressure to change the laws – really clarify them, since it’s not clear mandating grid connection is what they were ever intended for – would be overwhelming.
I still feel that way about it, but if anything the prospect of large-scale legal action has grown even dimmer. Many have begun arguing that grid defection is already legal, and all but daring local governments to come after them for it. A few have taken the invitation, but others have not, suggesting that prosecutors may not take up the cause the way utilities would like.
Industry-Wide Implications
I recognize of course that much of what I am saying is not limited to NextEra. All of the largest electric utilities in the country face the same issue. Why write this article on NextEra and not on Dominion (D) or Exelon (EXC) or Edison (ED)? Duke Energy (DUK) and Edison International (EIX)…the list goes on.
The unique factor about NextEra is that the regulatory changes that could set large-scale grid defection in motion are actually happening, not just being considered or proposed. NextEra derives the considerable majority of its operating profit from Florida utility operations; a threat to those operations is a threat to the company. But yes, if similar laws were passed in Illinois or Pennsylvania or North Carolina, much the same factors would apply. The threat is not unique to NextEra, but that is where the threat is most paramount at the moment, I believe.
Investment Summary
I went radio silent on NextEra because after the veto I didn’t really have anything to contribute that others weren’t already saying. Obviously paying full price for exported solar greatly reduces household incentive to even think about leaving the grid. Interest rates and energy costs were being well-explained by others already.
The new proposals out of Orlando indicate that the utilities are at least thinking about dipping their toes in the water again. To my mind, nothing that has happened in the last few years makes grid defection in the face of major pricing differentials any less likely.
It is still unclear to exactly what extent NextEra Energy’s price rally is based on the prospects of cutting renumeration rates for solar. To the extent that investors are pricing in the success of Orlando-like initiatives, statewide or nationwide, I think it’s a mistake. Of course, Partners and NextEra are both likely to also benefit from rate cuts, but it is also unclear just how many more rate cuts there will be.
Grid defection poses a massive risk to utility companies because they cannot reduce their fixed costs anywhere close to proportionately with the revenue losses defection causes. Such losses then snowball, or at least can if the policies causing them aren’t changed. The new Orlando news is indicative of continuing regulatory risk.
While I certainly don’t think these companies are short candidates, I am less persuaded of their imminent revival, and therefore remain Neutral on both.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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