The US's push towards renewable energy is gathering pace faster than thought and by 2030 this power source will generate more than 20 per cent of the national supply, Morningstar says.

Solar power in particular has been underestimated and in the next decade it could become the second largest source of energy behind natural gas, according to the latest Morningstar research.

In a new report entitled The Renewable Future, Morningstar outlines its US renewable energy forecast for 2030, and names three “clear cut winners” in the utilities sector that are set to capitalise on this shift.

Renewable energy is still a small player in the US energy ecosystem—just 10 per cent of US electricity sales and 7 per cent of US energy consumption, excluding hydropower.

But it is forecast to increase its share of the power generation market, say report authors Travis Miller, Charles Fishman and Andy Bischof.

“Oil, natural gas, nuclear, and even coal will keep us comfortable, charged, and on the go well into the next decade,” the report says.

“But we think renewable energy will grow up faster than consensus forecasts. US renewable energy— mostly wind and solar—will climb 8 per cent annually during the next decade, reaching 22 per cent of total electricity generation in our forecast.”

Utilities that can harness the growth in renewable energy will win big for investors, say the report, which singles out the following stocks: NextEra Energy (NYSE: NEE), Xcel Energy (NAS: XEL) and First Solar (NAS: FSLR).

Before we examine these stocks in more detail, let’s consider some of the key findings of the Morningstar report.

Morningstar's 2030 US renewable energy forecast

Morningstar forecasts that by 2030 US renewable energy will surpass 1000 terawatt-hours, or 22 per cent of US electricity generation, excluding hydro.

Tax credits for solar and wind power are set to be wound back in the next five years but Morningstar doubts this will slow growth to the level that some have anticipated.

“Our 8 per cent compound annual growth rate in 2018-30 is higher than global growth rate forecasts and higher than the 5.6 per cent forecast CAGR from the US Energy Information Administration, which has a history of underestimating renewable energy growth.”

Renewable energy vs natural gas

Renewable energy has closed the cost gap on gas generation, and the technologies are fighting for new investment throughout the US. And over the coming decade, solar and wind will overtake gas, the report authors write.

“Renewable energy has a policy advantage and will grow faster than gas during the next decade. We think gas will continue to grow, but only at a 2 per cent annual rate, down from 5 per cent during the last decade.

“Gas's demise is beyond our forecast period, but solar and wind will knock gas off its throne in many areas of the country by 2040, based on current technologies and policies.”

Sun shining on solar growth

The report cites solar power as the “key disrupter” and argues that it has been underestimated by energy sector experts.

A 2012 government-industry report suggested solar would struggle to reach 50 gigawatts and 11 per cent of US electricity demand by 2030. Solar already has 40 GW operating and 37.9 GW in construction or backed with signed contracts, according to Wood Mackenzie.

“Module [solar panel] shipments are exceeding GW per month. With some 200 GW in US grid operators' interconnection queues, solar could become the second-largest generation source behind natural gas in the next decade.”

In California, gas demand for power generation has fallen 30 per cent since 2015, and the state's zero-carbon target could mean eliminating all gas use by 2045.

Wind estimates too gusty

Whereas solar is the key disrupter, Morningstar argues wind growth estimates are too high.

The report authors note that in 2009, the North American electric grid monitor forecast 256 GW of installed wind capacity by 2018, far above the 99 GW now in service.

“In 2015, the US Department of Energy forecast that wind would hit 20 per cent of US electricity demand by 2030, well beyond what we think is possible.

“Wind bulls did not anticipate competing with natural gas for off-peak market share or solar for on-peak market share.”

Three top picks for the renewable future

In its utilities sector coverage, Morningstar recommends NextEra Energy, Xcel Energy, and First Solar. NextEra Energy and Xcel Energy trade at substantial premiums to Morningstar’s fair value estimates as of mid-October. First Solar trades at a slight discount to its fair value estimate. Following is the Morningstar analysts’ overview of these three utilities.

NextEra Energy (NEE)

Fair value estimate: US$193 | Earnings Growth Forecast: 8 per cent

As the largest wind power producer in the US, NextEra has proven itself to be a best-in-class renewable energy operator and developer. Management's continued execution on its Energy Resources development program leaves us confident that NextEra will deliver at the high end of its 11.5 GW to 18.5 GW development target in 2019 to 2022. Declining wind and solar costs position Energy Resources favourably during the next decade.

NextEra's early entry into battery storage will further enhance its competitive positioning in the market. It has two first-of-its-kind wind-solar-battery projects in development, one in Oregon and one in Oklahoma.

NextEra's regulated utilities in Florida also are moving into renewable energy with state support. By 2030, the utility aims to install 10 GW of new solar capacity, of which the utility earns near immediate returns upon completion.

The program would increase solar energy in Florida Power & Light's service territory to 20 per cent, up from roughly 1 per cent today. We forecast regulatory capital will increase 8 per cent annually through 2023. On a consolidated basis, we forecast NextEra's annual earnings growth will reach the top end of management's 6–8 per cent range and annual dividend growth will average 14 per cent through 2023. (Andrew Bischof)

Xcel Energy (XEL)

Fair Value Estimate: US$46 | Earnings Growth Forecast: 6 per cent

Xcel aims to be one of the industry's leading clean energy providers, with much of its US$20 billion planned investment during the next five years going to renewable energy. This investment plan gives investors a transparent runway of 6 per cent annual earnings and dividend growth potential.

However, Xcel's investment plan creates more regulatory risk than peers. It must continue to receive political, regulatory, and customer support for its clean energy investments, particularly in its largest jurisdictions, Colorado and Minnesota, where it plans to invest US$15 billion in 2019–23. Lower energy costs have helped keep customer bills mostly flat despite higher infrastructure charges.

In the long run, we think Xcel's investment in renewable and clean energy could top $1 billion per year to meet management's net-zero carbon goal by 2050. Colorado and New Mexico are working on legislation that would require 100 per cent carbon-free generation by 2050, supporting that long growth runway. (Travis Miller)

First Solar (FSLR)

Fair Value Estimate: US$59 | Earnings Growth Forecast: 27 per cent

First Solar is the only pure-play solar company in our coverage and is winning big contracts with key US developers. North America now represents two thirds of its potential booking opportunities.

But a surge in US demand doesn't make First Solar a slam dunk investment. Module makers like First Solar differentiate on cost and conversion rate—modules’ ability to turn sun into electricity. First Solar's thin-film technology gives it a slight advantage in both but not enough to warrant an economic moat. Maintaining margins and staying ahead of the competition will require First Solar to invest in new technology and production capacity. This is risky for investors.

Strong demand for its Series 6 modules released in 2017 and its smooth production capacity expansion is a win for investors so far. Bookings in 2018 and 2019 leave First Solar effectively sold out through 2021 at current capacity. Investors must watch if First Solar can stay ahead of the technology curve and expand production enough to offset lower margins in an increasingly competitive market. (Travis Miller)