PGIM Fixed Income research suggests investors in utility bonds should consider tactically allocating in favor of utilities with lower-carbon footprints.
The economics of coal-fueled electrical generation continue to be impacted by evolving regulations, shifting dynamics across commodity markets, declining costs of renewable electrical generation, and mounting environmental concerns. With these factors in mind, do utility bonds issued by more carbon-intensive utilities trade at a discount? Or are bonds issued by utilities with less reliance on coal—but with yields similar to their peers—the better trade?
These investment-related questions are addressed in a new paper, The Potential Implications of Investing in Coal-Heavy Utilities, by PGIM Fixed Income credit analysts Peter Cody, principal, U.S. Investment Grade Credit Research and Tatiana Spineanu, principal, European Investment Grade Credit Research. Cody and Spineanu argue that:
- Several market factors, such as cheaper natural gas and subsidized renewable costs (wind and solar generation), continue to make coal generation increasingly uneconomic and incentivize companies to adjust their generation sources.
- In Europe, the focus on carbon intensity/coal exposure continues to mount, particularly among Nordic investors, and a possibility exists that the European investing community places restrictions on coal assets, similar to its treatment of the tobacco sector.
- Although the credit markets have yet to distinguish between utilities’ current or future coal use, focusing exposure on those with less coal and carbon intensity can be thought of as cheap (or even free) insurance against the possibility that investors begin to demand a higher premium for the more carbon intensive utilities in the future.
- Therefore, it makes sense for investors in utilities to consider tactically allocating away from more carbon-intensive issuers (and those with slower carbon reduction plans) in favor of those with similar yields and lower-carbon footprints, or with only transmission and distribution businesses.
PGIM’s view: “If our bottom-up security selection process identifies a utility with a smaller environmental footprint or the prospects for a meaningfully reduced footprint in the foreseeable future—without giving up any yield—we select that security (all else being equal).”
Read The Potential Implications of Investing in Coal-Heavy Utilities and more market insights at pgim.com/insights.
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