Tag: Dominion

Dominion Energy (NYSE:D) continues to be a fascinating company to follow. Back in April, we wrote about how it was ideally positioned for the boom in energy demand coming from data centers. Data center-driven energy demand is now a widely embraced idea, but a few key aspects have changed that we believe secure a long growth runway for Dominion.

1. Demand speculation has solidified into verifiable and difficult to cancel requests
2. Regulatory environment is supportive of utilities as the primary source of incremental power generation
3. Substantive progress on Coast of Virginia Offshore Wind (CVOW)

In summation, these factors suggest Dominion can invest well north of $40B over the next 5 years at strong return levels that should be nicely accretive to earnings.

Demand solidified and verifiable

For a while, data center electricity demand has been speculated to look like this:

It still is, but the certainty of demand growth has improved materially.

Utilities were broadly concerned that many of the requests for power they were receiving were just potential developers testing the waters – essentially seeing if they could get power and at what price it would be available. This sort of “fake” demand could be troublesome if power infrastructure were built up to meet it and then the high power-consumption projects didn’t actually manifest.

Dominion is solving this problem by getting firmer commitments from would-be power consuming counterparties.

A recent S&P Global report described Dominion’s contracting process:

“The datacenter projects in Dominion Energy Virginia’s service territory, which represent more than 21 GW of demand, are divided among three levels: substation engineering letter of authorization, construction letter of authorization and electric service agreement. About 6 GW of datacenter capacity has progressed beyond the engineering planning phase to the second level, which involves entering into contracts that enable construction of the required distribution and substation electric infrastructure.

Meanwhile, about 8 GW of datacenter capacity has entered into an electric service agreement with Dominion. Customers in the second stage of a capacity contract must reimburse the company for its investments to date if they choose to discontinue their projects.”

These electric service agreements put the financial burden of pulling out on the data center rather than on the utility. With a financial commitment that large, Dominion is securing that the incremental power generation they build has customers lined up to consume it.

Through this process, a speculative demand boom has been transformed into hard contracts.

Regulatory environment supportive of utilities as main energy suppliers

With incremental demand forecast to approximately double electricity generation requirements, regulators have the difficult job of allowing sufficient incremental generation to be built while trying to prevent the financial burden of incremental demand from falling on existing customers.

On November 1^st, the Federal Energy Regulatory Commission or FERC held a conference at which a major topic of discussion was colocation of energy generation with large demand load.

Hyperscalers like Google (GOOG) along with independent power producers (IPPs) argue that colocating generation with load and tying them together with a power purchase agreement (PPA) allows the incremental demand to fund the incremental generation such that it reduces the impact on existing customers.

FERC panelists, including Commissioner Mark Christie seemed to largely disagree with this pitch, instead asserting that colocation with PPAs would allow data centers to circumvent transmission infrastructure fees, thereby putting the maintenance of transmission more directly on residential consumers. At the same time, the data centers would still be benefiting from grid transmission because they would be able to draw from the grid in the event their primary collocated generation facility went down.

Shortly after the panel, FERC voted to reject a colocation request between an Amazon (AMZN) data center and Talen Energy’s (TLN) Susquehanna Nuclear Plant.

Going forward, colocation requests are to be handled on a case-by-case basis, but this leaning of FERC against colocation supports a higher percentage of incremental power generation going through the grid and through utilities like Dominion.

The Public Service Commission of South Carolina and the North Carolina Utilities Commission are also supporting Dominion’s growth with fresh base case rulings at authorized ROE of 9.94% and 9.95%, respectively.

I see this as a Goldilocks level of ROE in that it is high enough to allow D to generate a healthy spread over cost of capital on incremental investment while low enough to not unduly burden residential household customers.

Dominion is among the lowest cost providers of electricity and projects that cost of consumers will rise slower than inflation.

Pathways to incremental power generation

With the regulatory side recognizing the need for more generation and substantial efforts to expedite approvals, Dominion is having good success getting its projects approved. The next step, of course, is to actually build the power generation.

Natural gas, solar and onshore wind have been around for a long time and all the major utilities are well versed in how to build these. They have done it before, and they can do it again.

Offshore wind is a substantially harder problem to tackle and could be the source of the market’s hesitation when it comes to Dominion’s stock. GE Vernova (GEV) is a leading servicer of a wide range of electricity generation, and they announced in their recent investor day presentation that they intend to fully exit offshore wind in the coming years.

Part of that decision is because the economics are seemingly much worse for servicers than they are for the operator portion of the industry vertical, but it is indicative of how challenging it is. Offshore wind has remained sparse in the U.S. despite being widely used overseas.

With CVOW, Dominion is positioned to become the U.S. leader in offshore wind, but that hinges on successful completion. Many have speculated this development would fail, and some market participants seem to still think it will fail. The data, however, is coming in very strong with all aspects of the development in line or better than original underwriting.

Monopile driving has begun with 78 successfully installed as of October 31^st. 98 remain to be driven in the following seasons.

2 deepwater undersea cables have been put in place and a majority of the required cable has been sourced.

The original expected completion was the end of 2026 and that remains the expected completion. Importantly, the budget still looks good, with the projected levelized cost of energy actually dropping to $56/MWh from the underwritten $80-$90.

Much of the reduced cost is related to Renewable Energy Credits or RECs increasing in value.

Full completion is still 2 years off, but it appears to be on the right track. CVOW will represent a substantial amount of incremental power generation.

Economics of capex for shareholders

Rate cases stipulate that just over 50% of the capex is financed with equity, and the allowed returns on equity seem to be in the high 9s.

At current market price ($53.86), Dominion’s cost of equity is about 6% and cost of debt is closer to 5%. D issued $1.2B debt in August at a split of 5.58% and 5.079% yield to maturity.

Since then, the Fed has cut by 75 basis points, so I suspect new issuance now would be closer to 5% even.

That spots overall cost of capital at about 5.5%.

Since allowed returns from regulators are phrased as ROE, the spread would be the delta between the high 9s allotted ROE and Dominion’s ~6% cost of equity.

Almost a year ago Dominion put out guidance for $43 billion capital investment between 2025 and 2029.

That was well before demand from data centers solidified into real contracts. Since then, Dominion’s contracted pipeline has expanded to well over 20 GW.

With much more demand contracted, I think the $43B figure will increase materially when 4Q24 earnings are released. That should be a key catalyst for D.

Since the company is generating a nearly 400 basis point spread between cost of equity and allotted ROE, higher investment volume equates to more earnings accretion.

Assuming 53% equity and 47% debt financing, a $43B pipeline represents incremental earnings of $2.21B. Of course, the share count would increase too, but given the strong spread, it would still be very accretive to the bottom line.

As the capital investment volume goes up to meet the growing secured demand, the magnitude of earnings accretion should rise proportionally. I anticipate D’s growth rate to expand into the high single digits and that once its 4Q24 numbers are released, Wall Street estimates are likely to reflect a faster growth rate.

Growth rate not priced into the stock

Utilities broadly, and Dominion specifically, seem to be priced as bond equivalents. Take a look at the 10-year correlation below between Dominion and the 20-year Treasury ETF (TLT).

When interest went up, both treasuries and D fell. When interest rates dropped, both treasuries and D rose.

That sort of lock-step pricing would be appropriate if Dominion just had static earnings, and that historically was the case for utilities, which just grew a few percent a year in a very slow and steady fashion.

Well, the environment has changed. We are no longer in an environment of 0 load growth. Electricity demand is soaring and with it, Dominion’s earnings growth rate has increased materially.

Given the lock-step pricing of Dominion with long-term treasuries, I don’t think the market has yet priced in the substantial increase in growth rate. When it does, I think Dominion will provide investors with significant capital gains on top of the solid 5% dividend.

Risks to Dominion and utilities in general

Politics and regulation are deeply involved in power generation, which adds uncertainty to what would otherwise be engineering. Government imposed regulations stipulate that energy production must transition to carbon-free over time, which would involve decommissioning certain existing means of power generation. Losing a power plant that already had capital investment is not ideal for cost efficiency of power production, so the proposed means of compensating this loss is to provide clean energy providers with various incentives such as RECs or the various forms of compensation introduced in the IRA.

In a steady political environment, utilities could easily navigate, but challenges arise with the uncertainty of the future political environment. Power generation is a long-term plan that will invariably go through a wide range of political parties in power, each of whom seem to have significantly different views on energy production.

So the risk to utilities is that if they pivot in the green direction to more fully prepare for carbon-free mandates/goals/regulations, they could get in trouble if the incentive packages which financially support this direction are cancelled.

On the other direction, if utilities stick toward keeping coal and natural gas plants around as long as they are allowed to, they could get in trouble in regulatory/political environments that shift toward being stricter on carbon.

Unless one can predict the future of politics, there is no clear answer as to where utilities should bias operations. As such, I tend to prefer companies that are well versed in a wide variety of energy generation. Dominion is well versed in nuclear, natural gas, solar and is becoming the U.S. leader in offshore wind. So while changing political winds will continually present risk, D is positioned to pivot accordingly.