Paul Hodgson: What chance net-zero for US utilities?

At the end of February 2019, New York City Comptroller Scott Stringer led a coalition of institutional investors representing some $1.8 trillion in AUM, including the New York funds, CalPERS, Hermes EOS, state of Connecticut and the Local Authority Pension Fund Forum, to demand the 20 largest electricity utilities in the US commit to achieving net-zero carbon emissions by 2050, one of the first asks of its kind.

The campaign was supported by a report from Climate Majority Project, formerly 50/50 Climate Project, Net-Zero by 2050: Investor Risks and Opportunities in the Context of Deep Decarbonization of Electricity Generation.

A year later, it seemed a good time to revisit the campaign to check in on its progress. In addition to Xcel Energy, which had already made a 2050 zero carbon commitment prior to the initiative, five more companies have made such a commitment out of the 20 targeted: Duke Energy, Dominion Energy, Pinnacle West, DTE Energy, and NRG Energy. “Xcel has committed to 80% decarbonisation by 2030,” said Eli Kasargod-Staub, Majority Action’s executive director, “which is a great move, as it enables them to spend the next 20 years dealing with the remaining 20%.” 

In addition, Xcel Energy is the only utility that incentivizes its executives to pursue emissions reduction targets. At the time of the launch, seven companies had targets for reducing reliance on fossil fuels, though not to net-zero, 12 had no targets at all. At the present time, more have introduced and/or increased their decarbonisation targets and now only six have no targets.

"When we launched this coalition, there was no other investor group that had drawn a clear, bright line to say this is what Paris alignment means for this sector, and that responding with answers that fall short of that doesn’t mean we will be engaging in an endless dialogue about who is right about this. We know we are right about this already." — Eli Kasargod-Staub

However, RI wanted to check to see what likelihood there was of these commitments being met. In 2018, the Edison Electric Institute (EEI) had most of its members sign up to and disclose a set of consistent ESG-related quantitative and qualitative disclosures.

We used the data point ‘Total Owned Nameplate Generation Capacity at end of year’ to make comparisons between companies’ renewable generation sources since it reflects generation capability rather than actual generation. But even these aspirational figures are, frankly, disgraceful in the main. Of the 20 utilities targeted by the campaign, Exelon, Vistra, NRG, Public Service Enterprise and AES are not part of the EEI reporting group, so no data is available on them. And of the others, 2017 appears to be the most recently reported year.

PG&E and NextEra are the only two respectable renewable producers at 52.6% and 33.8 % respectively, and most of PG&E’s comes from hydroelectric not solar, despite its location in California. And, of course, PG&E is now bankrupt due to its involvement in the state’s wildfires. But the rest are nowhere near as ramped up, including many of the net zero ‘committers’. Duke at 12.8%, Southern at 13%, and again only generated from a single source, hydroelectric, AEP has ramped up fivefold since 2000, but is still only at 14%, Dominion Energy is at 15%, but predicts that it will add another c12% by 2022. Xcel is at 7% right now, with that predicted to rise 3.5 times by 2030, at which time renewables will have overtaken natural gas and nuclear but will still be far behind coal generation! Evergy estimates renewable generation at 27% by 2020, but is only at 18-20% for now. DTE Energy is at 14.8%, with a ton of coal generation still. But then it just goes down and down: Ameren at 6.6%, OGE at 6.2%, WEC Energy at 6.9%, Pinnacle West at 2.3%, PPL at 1.2%, to the bottom with Entergy at 0.14%.

Net-zero by 2050?

It doesn’t look as if the majority of these have even a remote chance, especially those that have made a commitment. Kasargod-Staub said that commitments from companies that appear to be ill-prepared indicate at least a willingness to engage with investors and to reassure them that we are at least having the same conversation about what we need to achieve on decarbonization.

To try and boost the initiative, the New York City Comptroller and pension funds announced that it had submitted shareholder proposals requesting an independent board chairman at Duke Energy, Dominion Energy and The Southern Company for the 2020 proxy season. These companies were targeted because their “near term capital expenditures have been criticized for their continued reliance on fossil fuel expansion”, according to a report sponsored by Climate Majority called Investing in Failure. “With companies like Duke,” said Kasargod-Staub, “they are putting off some of their planned coal retirement decades into the future, and planning massive development of natural gas generation instead of leapfrogging to wind.”

The Nathan Cummings Foundation, another member of the coalition, filed a similar independent chair resolution at Ameren. Added Kasargod-Staub: “Ameren is 70% dependent on coal but has set a decarbonisation target of 80% by 2050, however it appears to be planning to achieve this also by the development of natural gas generation.”

Kasargod-Staub also pointed to key lobbying votes at Duke and Southern, important because climate policy non-profit InfluenceMap has identified these companies as being misaligned between their lobbying and their public commitments. “These key votes are a test for the largest asset managers to see if their commitment to support shareholder votes on climate issues will be fulfilled,” he said.

While members of the coalition were encouraged to vote against directors of companies that failed to make the zero carbon commitment, many members would have violated existing proxy voting recommendations to do so without other governance issues being of concern. In the case of Duke, Climate Majority put together an exempt solicitation to justify the vote for an independent chair, but to do something like this at every failing company was not practical.

The new report calls on the utilities “to take at minimum the following steps to put the companies on the path to decarbonization by 2050”: science-based CO2 trajectories, plans for replacing each company’s existing fossil fleet with alternative zero-carbon portfolios, renewable investment plans, grid-modernisation solutions and changing system needs, “including load growth driven by electrification instead of traditional steady demand”.

“When we launched this coalition,” said Kasargod-Staub, “there was no other investor group that had drawn a clear, bright line to say this is what Paris alignment means for this sector, and that responding with answers that fall short of that doesn’t mean we will be engaging in an endless dialogue about who is right about this. We know we are right about this already.”

These are great demands, but I think investors need a bigger stick. What is it, though? Not divestment.

Option repricing rears its ugly head

Talking of bigger sticks, investors might need one here as well. With the dramatic fall in stock prices due to the Coronavirus crisis, the ugly head of stock option repricing has been raised. Most, if not every stock option in the US will be ‘underwater’ by now; exercisable only at a higher price than the current market price and therefore ‘worthless’. Just a reminder of definitions, as it is a while since any of us had to deal with this: a stock option repricing involves employees giving up their existing options for the same number of options at a new, lower exercise price that is ‘at the market’, or that has an exercise price equivalent to the current market price. Other alternatives are available, for example a stock option exchange involves employees surrendering stock options and receiving, typically, a smaller number of options also at the lower market price.

The situation is very different from the 1990s, when companies routinely repriced options for CEOs and other senior executives whenever the stock price dropped significantly. Even during the 2008 financial crisis, some order had been brought to the table as both major US stock exchanges, NYSE and NASDAQ, required shareholder approval of a repricing or exchange, unless the approved plan already contained a repricing clause, as was the case at Alphabet (Google).

Exchange offers are much more likely to be approved by shareholders if they meet the following conditions: options are exchanged not repriced; the offer excludes senior management and the board; underwater options are exchanged at ‘fair value’; fewer options are issued in the exchange than are surrendered; dilution is reduced for shareholders; and the stock drop was due to circumstances beyond management’s control. Even proxy advisors have been known to recommend a vote for them.

While the current crisis meets the condition of ‘beyond management control’, forecasters are already signaling that any downturn is likely to be of relatively brief duration. A company that reprices its options and then bounces back in six months, creating windfalls for employees and, potentially, managers, would not be viewed with affection by investors whose investment has merely returned to the value it had before the crisis.

‘Can you reprice my shares, then?’ I hear them asking.

I do not see much sympathy for repricings or exchanges at the present, especially with the current round of massive layoffs. But be warned, they’re coming.