Environmental, social, and governance (ESG) ratings point climate-conscious investors away from companies that are not decarbonising fast enough (or at all!). But surely they should be doing the exact opposite when it comes to climate-critical sectors like electric utilities, explain Tricia Holland, Ryan Foelske, Ella Warshauer, Jon Rea, Sarah LaMonaca and Uday Varadarajan at RMI. Of course, that presents a new challenge. The investor first needs the analytical tools to see that the utility has put in place a realistic decarbonisation strategy. That’s why RMI are creating those tools in the U.S. The fact is electric utilities today are heavily dependent on fossil generation, so their ESG ratings don’t look good. But electric utilities should be in investors’ ESG portfolios precisely because they are significant carbon-emitters, say the authors. Not least because, according to RMI analysis, the investment opportunity to meet decarbonisation targets while electrifying the U.S. economy is about $3tn by 2035. That’s a win-win.

Although investor demand for environmental, social, and governance (ESG) funds has been both strong and resilient in recent years, the ESG sector is not without its shortcomings. Climate-conscious investors often struggle to evaluate the specific objectives and intended impacts of ESG-labelled funds, which can vary widely. Even after careful evaluation, investors could be allocating capital to funds that leave out a transition-critical sector, one that will require large amounts of investment to support economy-wide electrification: electric utilities. In order to build out the clean energy resources necessary to pivot away from fossil energy production, without compromising reliability or burdening ratepayers, the utility sector will need much more capital, not less.

With the right metrics and engagement support, climate-conscious investors can offer electricity providers both the funds and the accountability needed to cut carbon pollution sufficiently to limit global warming to 1.5C over pre-industrial levels. RMI is developing a new platform to help investors, whether ESG-focused or not, become a conduit for real utility transition at scale.

Electric utilities: the ultimate climate transition investment

Even as more renewable power generation comes online, the US electricity sector is still incredibly carbon-intensive, accounting for nearly one-third of total U.S. CO₂e emissions. Reducing utility carbon emissions is necessary to reach global climate goals, especially as other sectors like buildings and transportation electrify and rely more heavily on utilities. In fact, RMI modelling shows electrification of the US economy will approximately double electricity demand from 2025-2035. We will need to simultaneously reduce CO₂e emissions by 80 percent while we build out somewhere between six to nine times the renewable capacity we have today. To facilitate the energy transition and meet rising electricity demand, utilities require massive investment; RMI estimates the investment opportunity to electrify the US economy is conservatively valued at about $3 trillion by 2035.

Fail the ESG test? Maybe you need more clean investment, not less!

Despite this investment opportunity and critical transition capital need, in many cases, ESG criteria exclude companies exceeding certain thresholds of coal- or gas-fired power generation. This creates structural barriers that remove electric utilities from ESG products. Many utilities do rely on coal- and gas-fired power generation today, though some have submitted integrated resource plans (known as capex plans) that demonstrate progress towards climate alignment. To be sure, electric utilities must shift away from fossil fuel-based power generation as quickly as possible, but disengaging from them risks underfunding the necessary capital required to build the clean, renewable power generation and grid infrastructure needed for a successful transition.

Instead, investors looking to drive climate solutions through their investments should develop a more holistic approach that allows for both accountability and support. Investors can leverage their influence as shareholders, not only to push for high-level commitments, but also to support portfolio companies with robust analysis and actionable recommendations to reduce emissions. The US electric utility sector is uniquely positioned for this approach by offering clear decarbonisation pathways, relatively rich data, and business models that rely on funding from capital markets.

The electricity sector needs to reduce emissions by 80 percent by 2035 to be climate-aligned. While most investor-owned utilities have publicly stated emissions reduction targets, they are not ambitious enough, and progress on commitments to date has been lacklustre. In aggregate, utility decarbonisation targets, if achieved, will reduce emissions by just 50 percent. But achieving those targets is not likely based on utilities’ capital expenditure plans. Pressure from investors can be the key that bends the curve to a stable future, while delivering equally massive returns.

Forward-looking, capex-based metrics will help investors engage for real change

To thoughtfully invest in a way that is truly aligned with a clean energy future, investors need to look into the future. While using company targets to assess future progress can offer some initial insights, RMI analysis has found that, given utilities’ current capex plans, targets are both not climate-aligned and unlikely to be achieved.

Investors can use capex data, along with past production data, to assess historical and projected emissions for electric utilities in their portfolio, or to evaluate and select new investment opportunities. However, it’s not easy to produce good electric utility data. Electric utilities report a variety of information to a host of government agencies and organisations at different levels of complexity. While it may seem straightforward, obtaining a clear picture of a single electric utility using only one data source is not possible. Even when drawing on multiple data sources, the data cleaning process can be difficult and time consuming. Doing this for the entire electric utility sector is a monumental task.

Electric utility data aggregation and analysis

RMI is developing a platform to support engagement for action on climate — designed to help investors with the heavy lifting around electric utility data aggregation, cleaning, and analysis. This empowers investors to make more informed decisions about how to engage with electric utilities and where to deploy capital to have the greatest impact on the power sector. The platform offers investors:

• A unique data set on electric utilities that breaks down how each utility compares to a 1.5°C-aligned decarbonisation trajectory through to 2050.
• Pre-selected key metrics to evaluate climate risks and opportunities (such as energy burden, rate base composition, and generation mix).
• Electric utility deep dives that describe the unique decarbonisation risks and opportunities for individual electric utilities, including implications of the Inflation Reduction Act.
• RMI-authored thought leadership on the electric utility sector.
• Investor relations and engagement support, including one-on-one meetings with RMI electric utility experts, electric utility earnings call recaps, and more.
• Accountability metrics to track progress towards decarbonisation.

Electric utilities should be in investors’ ESG portfolios precisely because they are significant carbon-emitters. Electric utility-specific data and metrics can equip investors for productive engagements that steer electric utilities towards investing in the best possible climate outcomes, and help investors hold electric utilities accountable for reaching their climate goals.

RMI’s forthcoming platform can help climate-focused investors engage and invest in the critical electric utilities sector to drive decarbonisation with unique, forward-looking metrics, thought leadership, and engagement support.

RMI is looking for partners to continue co-development of this platform. To learn more, contact Ryan Foelske (rfoelske@rmi.org) or Tricia Holland (tholland@rmi.org) for more information.

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Tricia Holland is a Senior Associate, Climate-Aligned Finance, at RMI

Ryan Foelske is a Manager, Carbon-Free Electricity, at RMI

Ella Warshauer is an Associate, Climate-Aligned Finance, at RMI

Jon Rea is a Senior Associate, Carbon-Free Electricity, at RMI

Sarah LaMonaca is a Manager, Climate-Aligned Finance, at RMI

Uday Varadarajan is a Senior Principal, Carbon-Free Electricity, at RMI

This article was first published on RMI.org, and has been reprinted with permission