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Following the passage of the Inflation Reduction Act (IRA) which was signed into law by President Biden on August 16, we’ve been commenting about how the $369B in spending on energy and climate initiatives will be a gamechanger to fast track and insulate numerous projects intended to decarbonize the US economy with a goal towards reaching the President’s target for a reduction in GHG emissions to 50% below 2005 levels by 2030. Though we have already highlighted the IRA benefits to utilities with exposure to nuclear generating capacity – namely with our bullish thesis on Constellation Energy (CEG), link here, and here, the IRA benefits are just as impactful to other forms of alternative (or renewable) energy as well. The key IRA provisions can be summarized as follows:
NextEra Energy (NEE) is a clean energy company headquartered out of Juno Beach, Florida. NextEra owns two cornerstone companies – NextEra Energy Resources (NEER) and the Florida Power & Light Company (FPL). NEER is the clean energy business which happens to be the world’s largest generator of renewable energy from wind and solar. It also is a world leader in battery storage. FPL is the nation’s largest electric utility by retail MWh sales while also selling the most power to the largest customers base than any other utility (power sold to more than 5.7M customer accounts, supporting more than 12.0M residents across Florida). The company, operates an assets base generating 62.0GW and has a history of delivering value to shareholders (since 2006, adjusted EPS has grown at nearly 8.4% CAGR while the DPS has grown at nearly a 10% CAGR). Paramount to the company’s success has been its ability to buy at scale, operate at scale and build at scale.
The company’s vision is clear for the longer term as the decarbonization strategy is three pronged: 1) Decarbonize the company (achieve real zero carbon emissions by no later than 2045. Do this by executing on the largest renewables buildout by an electric utility in the country), 2) Decarbonize the US electric sector (decarbonize other investor-owned utilities, municipalities and cooperatives to reduce customer bills – this is a $2.0T opportunity) and finally 3) Decarbonize the broader US economy (provide a one stop shop for solutions to build new renewables and storage in order to enable customers beyond the power sector to decarbonize and reduce electric costs – given 7,000GW, this is estimated to be a $4.0T opportunity). In the nearer term, this vision will be executed given an expected $85.0B-$95.0B of capital deployments (this includes in transmission) expected between 2022 through to 2025. NextEra expects to remain a top-5 capital provider in US infrastructure.
Along with the increasing needs for sustainable solutions (partly spurred by regulatory initiatives) the primary driver for renewable energy remains an economic one (given high power, natural gas and oil prices, a lack of pipeline capacity and coal-to-gas switching, renewables (along of course with nuclear) are considered to be the lowest cost form of generation). Renewable power generation is a deflationary product tailor made for the current inflationary environment – this economic dynamic became even more compelling given the passage of the IRA. Being one of the biggest beneficiaries towards this emerging renewable LT theme, one can easily see why higher valuation multiples are warranted for NextEra, in relation to the established “OldEra” utilities which rely largely on thermal generation.
Recall that the PTC for wind and solar credits include a provision which lasts until “when GHG emissions for US electric generation is reduced 75% from 2022 levels”. According to NextEra, this time will come only sometime in the 2040s. In that case, NextEra will benefit from a 100% PTC and 30% ITC for at least two decades. Two decades of credits will provide the company with tremendous visibility into long term growth. This will unlock and insulate further renewable growth potential allowing for the repowering of existing projects (along with the rollout of new projects) and accelerate stand-alone storage at existing sites. New technologies such as green hydrogen solutions have also been enabled and will be supported going forward. At FPL alone, investments to be prioritized already include plans to add 92GW of solar, 50 GW of battery storage capacity and initiatives to convert the natural gas plants to run on green hydrogen. These are the types of investments which will make power production not only more reliable, but cheaper as well for the end customer. Note that as of this summer, 95GW+ of equivalent land has already been secured for future development with 70GW+ of interconnect. Smaller independent developers simply cannot secure that much land to generate the best and most efficient resource.
Paying for growth is part of the story but so is paying for a 30+ year track record of successful development. Scale matters and expertise matters (especially for permitting, land acquisition and management and interconnect management). That is how margin is extracted - by buying cheaper, financing cheaper and building cheaper. Going forward, NextEra will continue to extract margin from all of those fronts.