Stocks to Watch in Utilities

Even in city centers like San Francisco customers are going solar, a challenge to utilities. Image: SunPower

Disruption is happening quickly in the utility industry, a business that's gone nearly unchanged for over a century. Concerns about the environmental impact of burning coal and natural gas have put pressure on utilities to build cleaner plants and new forms of energy like wind and solar are now competitive on a cost basis with fossil fuels.

Complicating matters further, distributed energy, which is generated on home or business rooftops, is starting to upset the utility business model. Now instead of being a one-way transaction, electricity can be produced at home and even sent back to the grid through net metering. Below I'll explore the disruptions taking place in the utilities and highlight three stocks to watch to see how the industry is handling its challenges.

Customers putting solar on their roofs is the biggest challenge in Hawaii. Image: SunPower

Hawaii's utility conundrumHawaiian Electric Industries , which has agreed to be acquired by NextEra Energy for $4.3 billion, is the main supplier of electricity to Hawaii and it's also the most threatened by new energy technologies. One in nine homes in Hawaii has a solar system on it, meaning that thousands of homes are producing extra energy that they send to the grid in the sunny afternoon and then are suddenly sources of demand in the evening hours. Hawaiian Electric argues that this creates a strain on the grid and the company fought adding more homeowner systems to the grid as a result. But with electricity rates that exceed 30 cents per kWh, nearly three times the national average, consumers are in search of cheaper forms of energy and solar is now a viable option.

What investors will want to watch here is how the dynamic between Hawaiian Electric and regulators plays out. For the first time, regulators have really pushed back when the utility fought connecting customer owned solar systems to the grid. In Hawaii at least, regulators are going to force the utility to adapt to renewable and distributed electricity generation (rooftop solar) and that's something to watch very closely no matter how you're invested in energy.

The fight over energy in Arizona Arizona Public Service, or APS, is Pinnacle West Capital's utility in Arizona and it's put up one of the harshest fights against solar in the U.S. The company got regulators to approve a $5 charge per month for solar customers and recently asked that to be raised to $3 per watt ($15-$24 per month for a typical residential rooftop system). If approved, it would effectively kill residential solar installations.

Arizona is a perfect location to put up solar panels, but APS is trying to fight customers creating their own energy, a threat they saw take hold quickly in Hawaii, by building rate structures to kill the industry before it gets started. Minimum charges or access charges lower the return on investment for solar systems and it's why SolarCity pulled some of its workers out of the state last month.

Energy storage is either a threat or an opportunity for utilities depending on how they look at it. Image: Stem

While Hawaii is going to have to show how solar and utilities can work together due to the state's high electricity costs, APS is laying the groundwork for how to fight solar in the 49 other states. Every other utility in the country is watching how the utility fights solar and many are sure to copy APS's strategy if it's successful in slowing the solar boom.

Xcel Energy Hawaiian Electric and APS are under immense pressure from distributed energy and they're handling it in different ways. But to see how a more typical utility is handling changes in energy I would watch Xcel. The company generates most of its energy from Midwestern states like Minnesota, Michigan, Wisconsin, and the Dakotas. Solar energy isn't exactly a big threat in those locations, but it's on the company's long-term horizon.

Where Xcel has gotten out ahead of the curve is in utility solar and wind, where it's been one of the most supportive utilities when it comes to renewable energy. Renewable energy accounted for 24.2% of NSP System's total energy in 2014 and 13.7% came from wind. It is also building solar gardens in Minnesota and Colorado that customers can invest in and get their energy from.

Xcel Energy is also expecting to add more wind and solar capacity in coming years across the states it serves. But being friendly to wind and solar when you can dictate the terms and even own the assets is different than when customers start building their own energy production, like they are in Hawaii and Arizona. What I'll be watching in coming years is how Xcel Energy transitions to dictating terms of renewable energy deals to working with customers to make their rooftop solar systems work with the grid. That transition may not be as simple as it seems.

Utilities are in for a wild rideFor decades utilities have been seen as a very safe investment, but that may not be the case in coming years. They're facing challenges they've never dealt with before and for the first time in states like Hawaii leaving the grid altogether is a very real option for consumers. How utilities adapt will be worth watching for all energy investors.

The article Stocks to Watch in Utilities originally appeared on Fool.com.

Travis Hoium owns shares of SunPower. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.