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How Rising Utility Bills Are Reshaping the US Economy
Explore how soaring consumer utility costs are creating a new reality for utilities stocks, challenging their long-held status as stable investments.
Key Takeaways
We expect customer bill pressure to limit utilities’ ability to meet earnings growth expectations.
Investors should focus on utilities with constructive ratemaking policies, such as timely cost recovery and high allowed returns on equity.
Our regulatory rankings consider allowed returns on equity, timely cost recovery, management’s ability to keep meeting regulatory budgets, and the stability of the regulatory environment.
Utilities stocks have long been considered an attractive investment. Customer bills benefited from low interest rates and stable energy prices while investors enjoyed growing earnings and attractive returns.
However, utility bills are now on the rise. Electric utility prices were up 6% year over year in August for the third consecutive month. Gas utility prices were up 14% year over year in August, the highest of all spending categories, per the Department of Labor's monthly Consumer Price Index report.
The utilities sector is planning major infrastructure investments to keep up with demand. As such, regulators must choose whether customers or investors pay, and professional investors will need to keep an eye on policies and rate structures across state governments.
The US Utilities Sector report dives into consumer cost impacts, state-by-state data on regulatory updates, and top picks for US utilities poised for stable earnings. For a more complete look at this evolving sector, download the full report.
Rising Utility Bills and Their Impact on Earnings Growth
Approximately half of the average customer bill consists of energy costs, taxes, and other fees that utilities incur and pass through to customers with no markup. The other half is the revenue that utilities collect to pay operating costs, capital costs, interest, income taxes, and dividends.
Increases in all of these costs had elevated electricity prices in the past five years. Since the beginning of 2021, year-over-year electric utility bill inflation has been greater than total inflation in 70% of the months.
Overall, these rising costs could lead to regulatory actions like rate freezes or reduced allowed returns on equity, directly affecting utilities’ earnings growth and stock valuations.
The impact varies by region. In the Northeast, residential electricity rates have risen 17% on average since 2022, with Connecticut and New York facing significant regulatory and political challenges.
On the West Coast, rates have increased 24% on average, driven by California’s zero-carbon mandate and wildfire mitigation investments.
In the mid-Atlantic, residential electricity rates have gone up 17% on average since 2022. PJM operates the largest electric grid in the US, serving 67 million people in 13 states from Chicago to New Jersey. Earlier this year, PJM raised its 2030 peak electricity demand forecast by 16 gigawatts, or nearly 10%. Higher capacity prices in the PJM region are pressuring customer bills.
What’s the Current Regulatory Environment for Utilities?
To determine our regulatory rankings and moats for the utilities sector, we assess each company’s regulatory environment on four primary factors:
- Allowed Returns on Equity: Higher allowed ROEs provide a financial cushion against higher interest rates. Utilities with 9.5%-10.0% allowed ROEs typically receive an average score.
- Rate Adjustment Timing: Timing between cash costs and cash recovery affects return on invested capital. Regulatory lag can slow dividend growth even if earnings are growing.
- Management Execution: Utilities must work with regulators and customers to achieve fair rate outcomes. Keeping operating and capital costs within regulatory targets enhances shareholder returns.
- Regulatory and Political Stability: Stable regulatory and political environments reduce investor risk. Changes in the regulatory or political landscape can affect valuations.
Despite current challenges with higher interest rates and inflation, we still think most utilities have narrow economic moats. This means utilities still have a competitive edge and attractive return potential. With a narrow moat, we expect that edge to last around 10 years rather than 20 years, as with a wide moat.
Regulated utilities benefit from service territory monopolies and efficient scale advantages, allowing them to charge rates that provide fair returns on invested capital while minimizing customer costs. In inflationary periods, regulators typically adjust rates to reflect higher costs, supporting the long-term ability of most utilities to outearn their cost of capital and maintain narrow economic moats.
Advisors should focus on utilities with strong regulatory relationships and cost recovery mechanisms to safeguard against potential valuation declines.
Here are Morningstar’s top picks in the utilities sector with the most favorable regulatory conditions:
Advisors should be cautious of no-moat utilities that struggle to earn their allowed returns, as these may face prolonged periods of slow earnings and dividend growth. Advisors should evaluate the price-to-earnings ratio, dividend yields, and earnings growth potential to fully inform their portfolio management decisions.
For a more complete look at our rankings and our stock picks for the sector, be sure to download the full US Utilities report.
Top Utility Picks for Growth
The following are our top utilities stock picks poised for growth in the sector:
Duke Energy: This fully regulated utility has an $95 to $105 billion five-year capital investment plan focused onsupporting electricity demand and infrastructure upgrades. Regulatory improvements in North Carolina and South Carolina support the high end 5%-7% annual earnings growth target.
Alliant Energy: The company is positioned for growth with an $13.4billion capital investment plan and opportunities in data center expansion in Iowa and Wisconsin that should support more than 7% earnings growth beginning in 2027.
Edison International: The market is overestimating Edison’s worst-case wildfire liabilities. California legislation provides financial protections for the state’s utilities, giving us confidence that Edison can execute its $7 billion annual investment plan and realize 7% annual earnings growth.
Eversource Energy: The company is recovering from regulatory challenges in Connecticut but has growth potential in interstate transmission and Massachusetts investments.
Challenges Ahead: Higher Costs and Regulatory Lag
Rising interest rates have narrowed the spread between allowed returns and the 10-year US Treasury yield, creating headwinds for utilities.
Regulatory lag and political pressures may delay cost recovery or lead to project cancellations, affecting utilities’ ability to maintain earnings and dividend growth. Rate freezes and tighter operating budgets could further challenge utilities in an inflationary environment.
Investors should evaluate regulatory rankings in this report and leverage risk assessment tools like Direct Advisory Suite. Advisors can use these tools to ensure portfolio allocations are aligned to client goals in light of evolving opportunities for income investors.
