Tesla Throws Down the Gauntlet

May 14th, 2015
in contributors

Investing Daily Article of the Week

by Ari Charney, Investing Daily

The century-old business model for power utilities is facing its biggest threat in more than a decade. Sweeping technological changes coupled with a strong regulatory push toward lower emissions is forcing utilities to contemplate whether the grid will eventually be relegated to a backup role.

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Despite such existential considerations, utilities still boast the considerable power of incumbency. While some utilities are making only token efforts to adapt to the evolving operating environment, others, such as NextEra Energy Inc. (NYSE: NEE), are making great strides toward increasing the role of renewable energy in their generation portfolios.

At the same time, we're less than two years away from a new presidential administration that may not be as favorably disposed to expansive environmental regulations, such as President Obama's proposed Clean Power Plan. But regardless of what happens at the polls, federal power rarely gets rolled back and, therefore, increasing regulatory oversight seems almost inexorable.

Indeed, even a quick glance at the magazine published by the Edison Electric Institute, the association of investor-owned power utilities, shows an industry that has shifted from grudging acceptance of renewables to actively pursuing new technologies to stave off challenges from new market entrants.

In navigating this changing landscape, one of our main tasks as investors is to separate hype from reality. After all, great change can also be accompanied by great chicanery. And even promising technologies backed by good-faith efforts can still end up failing.

That means knowing when to discount the almost messianic zeal of green-energy boosters, whose latest technologies are part of an increasingly crowded market that still depends in large part upon significant government intrusion in the form of both regulations and subsidies.

Based on what we know at the moment, the biggest challenge to utilities' regulated monopolies will come from consumers themselves in the form of distributed generation.

We're getting closer to the day when it will be easy and affordable for consumers to generate their own electricity via rooftop solar panels during the day, while storing excess power in special batteries on-site for use at night or other periods of peak demand when sunlight is lacking. But we're not quite there yet.

The latest advance in this potentially disruptive technology was announced last week with great fanfare: Tesla Motors Inc. (NASDAQ: TSLA) CEO Elon Musk unveiled his company's new line of lithium-ion Powerwall batteries for the residential and business markets.

The batteries are basically a repackaged version of the ones Tesla already uses in its electric cars. For $3,000, you can get a 7 kilowatt-hour unit, while $3,500 gets you a 10 kWh unit, though neither price includes the cost of installation.

That may still be prohibitively expensive for the average consumer, but it's apparently dirt cheap compared to what's already on the market.

The cleantech-focused news site CleanTechnica surveyed so-called off-gridders about the other batteries most commonly used to get a sense of the relative savings Tesla is offering, and they're substantial: The cheaper model is more than $4,500 less than the average price of the four other batteries cited, while offering superior storage capacity and an unmatched 10-year full guarantee.

The U.S. Energy Information Administration says that in 2013 the average home used about 909 kWh per month. So that means Tesla's 10 kWh battery has sufficient capacity to power a home for about 8 hours.

Nevertheless, those prices points mean that for now residential use of the batteries will essentially be a luxury science project for wealthy enthusiasts of going green.

In fact, according to The Wall Street Journal, the battery is just one small part of a system that could cost $20,000 or more, when including solar panels, smart controls, building permits, and labor.

But there are plenty of people with such money and passion. Demand has been brisk for the sleek, wall-mounted models, whose minimalist, modular design is reminiscent of the pleasing aesthetic that Apple introduced to the personal-computing space.

During Tesla's earnings call earlier this week, Musk announced that the company already has 38,000 pre-orders for the new batteries, meaning that they're effectively sold out through mid-2016. And the average pre-order includes 1.5 to 2 Powerwalls per installation, thus confirming that early adopters have deep pockets.

Even so, Musk, himself, expects most of the initial demand will come from industrial companies seeking to sharply lower their electricity costs by deploying Tesla's batteries.

In addition to the residential battery models, Tesla also offers a scaled-up version for industrial use called Powerpack, with individual battery units that can be combined via a cabinet-and-rack system for a total possible capacity of 5 megawatt hours. Pre-orders for Powerpack totaled 2,500, with an average of 10 batteries per order.

In characterizing the deluge of demand, the giddy 43-year old billionaire sounded like he was channeling Dobie Gillis' beatnik sidekick Maynard G. Krebs: Musk said;

"The volume of demand here has just been staggering. It really feels like, man, the stationary storage demand is just nutty. Like, worldwide, it's just crazy."

And given all the competition in this tiny, but rapidly growing market-Tesla's batteries are competing against offerings from other well-known firms such as Samsung Electronics Co. Ltd. and LG Chem Ltd.-the price of such batteries will continue to fall, spurring even more demand.

Tesla, itself, says that once its new Gigafactory becomes operational in 2017 the company should be able to cut its costs of production by 30%, thus affording it even greater flexibility in pricing.

From the standpoint of a utility investor, however, the advance of such a technology is potentially worrisome.

Slow economic growth and rising energy efficiency have kept a lid on electricity demand. Total sales of electricity last year were still down about 1.1% from their pre-recession peak in 2007.

So it's hard to get excited about the prospect of a continually improving technology that empowers consumers and businesses to further pare already-lackluster demand.

However, that assumes that utilities do nothing to counter this threat. As the incumbents, they still have the power to slow the adoption of a new technology, as we've seen in their resistance to net metering, where customers with rooftop solar can sell any excess energy they generate back to the grid.

But the ultimate jujitsu move would be for utilities to adopt the most promising technologies, using their greater efficiency to reduce operating expenses, comply with renewable energy standards, and boost reliability, all the while passing along the cost of the investment to customers via rate base.

There are signs that utilities have already been doing just that. According to GTM Research, last year $128 million worth of batteries were installed in the U.S., mostly at utilities. By contrast, just 1% of the capacity was for residential use.

The WSJ notes that utilities such as Duke Energy Corp (NYSE: DUK) and Edison International (NYSE: EIX) have installed large battery systems next to their wind farms.

And that's an important reminder that utilities, such as Duke, Southern Co. (NYSE: SO) and Dominion Resources Inc. (NYSE: D), that have scale, strong balance sheets, and constructive relationships with regulators, are the ones most likely to prevail regardless of how the utility business model changes.

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