Electricity will replace petroleum as the primary transportation fuel in the US, with much of this juice coming from solar-powered batteries in homes and businesses—that’s the vision laid out by Jeffrey Straubel, CEO of Tesla Motors (NSDQ: TSLA), at the Energy Information Administration’s (EIA) annual energy conference.

According to Straubel, this evolution will render utilities and oil companies obsolete. Such hyperbole is nothing new for Tesla Motors or its sister company, SolarCity Corp (NSDQ; SCTY), currently the leading US provider of rooftop solar-power systems.

The pair’s founder and chief pitchman, billionaire Elon Musk, plays up his companies as disruptors that will rule the automobile and electricity markets of the future. This vision has no shortage of fans on Wall Street and Main Street, who, thus far, have enabled the cash-guzzling SolarCity and Tesla Motors to bridge yawning funding gaps.

Straubel’s presentation, predictably, was heavy on hype. But the EIA’s annual conference isn’t a stock promoters’ pep rally; this must-attend event for energy and policy wonks often takes a longer view than most companies and focuses on key topics that will shape the industry in coming years and decades.

At this year’s conference, energy storage was one of the major themes. But most presenters and attendees focused on how energy-storage solutions can improve grid reliability and economics. Viewed in this manner, these innovations enhance the long-term competitive advantage of the existing power grid.

Rather than a disruptive force, energy storage creates a massive investment opportunity for electric utilities, especially with growing political and regulatory support ensuring reliable returns on capital expenditures.

Consider some of the projections from the Energy Storage Association (ESA), an industry group of almost 100 electronics, engineering, power generation and utility companies. According to Katherine Hamilton’s presentation at the EIA conference, installed battery storage capacity could climb from 340 megawatts in 2013 to 6 gigawatts (GW) by 2017 and more than 40 GW by 2022. The ESA’s forecast also calls for 220 megawatts of battery storage to be be deployed this year.

The primary motivations for this growth are improved efficiency and reliability that will cut the cost of grid electricity. Among other advantages, reliable stored energy would eliminate the need to build expensive peaking power plants that fire up to prevent outages during periods of peak demand. Such a development would reduce utilities’ capital expenditures and permitting, operating, maintenance and environmental costs.

Deploying storage technologies at existing power plants can increase output, boost efficiency and reduce emissions. Applying these solutions to transmission systems limits the strain on existing infrastructure during periods of peak demand and provides a cushion during planned and unplanned facility shutdowns.

Electric utilities drive revenue and earnings growth through system investment, ideally to cut long-range costs and improve efficiency. State and federal regulators usually grant rate increases that provide a fair return on investment. Assuming these projects are completed on time and under budget, these investments fuel low-risk earnings and dividend growth.

Over the past century, much of utilities’ investment has gone toward power plants. But in recent years, the need to improve system reliability—especially during periods of peak stress—has led to a boom in transmission investment, spurred by favorable rates of return from the Federal Energy Regulatory Commission (FERC).

The industry appears to be on the verge of another shift in capital expenditures, this time to distribution systems. Nevertheless, the ultimate goals remain unchanged: improving reliability and efficiency while cutting long-run costs. An uptick in billion dollar outages caused by severe weather has added urgency to this latest wave of investment.

Electric utilities also need to modernize their systems to support increased adoption of distributed generation, primarily rooftop solar panels.

The stakes are high. For utilities able to invest and earn a fair return, capital expenditures on distribution infrastructure will power robust earnings and dividend growth to the end of this decade and beyond. Those that can’t evolve—either because of poor regulatory relations or shortsighted management teams—will suffer stagnant to declining earnings.

Distributed Energy: Boon Not Bane

For electric utilities, the biggest risk from the development of legitimate energy storage is that these solutions will enhance the economics of rooftop solar power. Unless incumbent power providers successfully integrate distributed energy, they could suffer system imbalances and lost sales as customers to cut the power cord.

Over the past five years, the cost of rooftop solar panels and related equipment has dropped by about 40 percent, while the expenses associated with battery storage have declined by 65 percent. The consensus outlook envisions additional gains as development ramps up and technology advances.

But for Tesla Motors, SolarCity and other would-be disruptors to win share from electric utilities, the benefits of storage technologies to distributed energy would need to vastly outweigh the positives for the grid. And in most places, the numbers simply don’t add up.

In 2013, the Brattle Group rattled the electric power industry with a report that warned of a potential “death spiral” for US utilities.

The rationale behind this bold prediction: Expenses associated with grid improvement had increased at the same time that the economics of rooftop solar-power installations were improving rapidly. In the worst-case scenario laid out by the Brattle Group, customer attrition would force utilities to raise prices, prompting even more defections to distributed power.

We’ve expressed deep skepticism of these assertions since the Brattle Group’s report first appeared.

For one, similar arguments gained traction in the 1990s, when deregulated power markets were expected to hand the future to the likes of Enron and fuel-cell maker Plug Power (NSDQ: PLUG).

At one time, Plug Power’s stock rallied to almost $150 per share after General Electric (NYSE: GE) endorsed the would-be distributed energy technology as the power system of the future. Today, Plug Power trades for about $2.60 per share, and the company has yet to turn an operating profit. Enron, of course, no longer exists, except as a cautionary tale.

But the Brattle Group’s most recent research raises questions about its initial conclusion that electric utilities are poised for a death spiral. The economic consulting firm’s presentation at the EIA conference highlighted the results of a “stress test”  designed to answer one fundamental question: Will off-grid electricity be able to compete on cost, making it economically feasible for large numbers of customers to defect from electric utilities?

The stress test occurs during what the Brattle Group described as “an extremely positive environment for off grid resources.” Accordingly, the study’s assumptions about future cost reductions in photovoltaic solar panels and storage batteries were “aggressive” and “represented substantial declines from the present.” Similarly, assumptions about reliability were based on “weather-normalized” conditions that were considerably “less expensive” than in the real world.

The study assumes that installation costs for rooftop solar panels would continue to fall as contractors gained experience. And it based forecasts for future solar and battery costs at the low end of the spectrum, with the caveat “actual costs are likely to be higher, perhaps significantly.”

Brattle Group’s analysis gives considerable weight to customer motivations in its forecast, factor that has little to do with cost but could drive economies of scale. These consumer-oriented goals include improving reliability, reducing carbon dioxide emissions, eliminating reliance on regulated utilities and various prestige-related factors.

The company used three areas as a model to represent the varied conditions for solar radiation in the US: Los Angeles, Houston and New York’s Westchester County. Based on the most favorable assumptions for distributed energy, the company forecast a 20-year average cost and compared it to the EIA’s reference forecasts for grid energy. The 20-year period reflects the useful life of current rooftop solar systems and the typical contract duration.

The results, summarized in “Tesla’s Legacy,” are rich in irony and confirm the dream of Nikola Tesla—the man for whom Tesla Motors is named—of a world served by grid electricity, i.e. alternating current, rather than the direct current of battery technology.

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In Texas, for example, all-in residential costs for a solar power and battery system were $0.311 per kilowatt-hour under the most aggressively favorable assumptions. In California, the same number came in at $0.242; in Westchester County, it was $0.315.

Even in sun-drenched southern California, residential customers who cut the cord entirely will pay 2.42 times more for their electricity than those who stick to the grid. The advantage of staying with the utility is 4.3 times in Houston. And it’s 1.4 times in New York’s Westchester County.

Systems designed for the commercial market—in this case, a large office building—offered improved costs, but still fell short of grid power.

Integrating rooftop solar, battery storage and natural-gas backup generation didn’t fare much better, even with very low cost assumptions for gas prices.

The Brattle Group drew two major conclusions from its study:

• Even with aggressive assumptions regarding cost improvements for solar panels and battery systems, leaving the grid won’t be the least expensive option; and
• Although distributed solar power appeals to customers who are intent on sticking it to the local utility company, a reliable grid remains critical to the country’s economic health and the population’s well-being.

Besides lower electricity costs, the Brattle Group’s presentation cited several other advantages of a centralized grid, including the ability smooth the load to improve reliability and eliminating wasted energy generated when multiple systems run.

The consulting firm’s conclusions suggest that state and federal policies should ensure that the adoption of distributed generation enhances the grid instead of undermining this critical infrastructure.

The question is whether policymakers reach a similar conclusion. One of the first test cases will occur in Hawaii, where Hawaiian Electric Industries (NYSE: HE), a name we recently sold from our Aggressive Income Portfolio for a 30 percent gain, and its would-be acquirer NextEra Energy (NYSE: NEE) will hammer out details for an open grid that will accommodate more distributed power sources.

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However, federal policy for the Lower 48, likely will focus on supporting a centralized grid. At the EIA energy conference, FERC’s Bob Hellrich-Dawson delivered a presentation on energy storage that indicated the regulator’s willingness to support efforts to advance these technologies and move their implementation forward.

This sentiment and other business considerations have convinced many renewable-energy companies that the fastest road to big returns is to partner with utilities, as opposed to disrupting them.

Tom Werner, CEO of SunPower Corp (NSDQ: SPWR), recently told analysts that the company “[has] always viewed solar power as a partnership with utilities.”

Meanwhile, Tesla Motors recently inked a deal to develop battery storage with Southern Company (NYSE: SO) and CEO Elon Musk pitched these solutions at a utility industry conference in New Orleans.

Meet the Winner

The growing collaboration between clean-energy upstarts and utilities is one of the key takeaways from Renewable Energy: How to Make Green and Avoid Red, a comprehensive report on investing in renewable energy that’s available exclusively to Conrad’s Utility Investor subscribers.

One likely winner from all this upheaval and innovation is AES Corp (NYSE: AES), a multinational utility that generates the bulk of its $16 billion in annual revenue by producing and distributing electricity.

The company is in the midst of streamlining its asset portfolio to focus on core systems, with the funds from these asset sales going toward stock buybacks, debt reduction and a $7 billion project backlog. AES Corp last week issued five-year notes with a 3.45 percent coupon to refinance maturing debt with roughly two times this interest rate.

However, the company has also emerged as a leader in the development and deployment of energy-storage solutions, though this business represents a sliver of its overall revenue mix.

AES Corp won a 100-megawatt storage project in California that’s slated for completion in 2020 and sees more opportunities to come if battery costs fall by 50 percent over the next five years.

AES Corp recently completed a 4-megawatt distributed energy project in Laurens County, Georgia, that will sell power to Southern Company under a 20-year deal. The firm is also building a 16-megawatt project that will come onstream in the first half of 2016.

The firm also continues its aggressive pursuit of distributed-power solutions with commercial and industrial customers in Chile, Colombia and other rapidly growing emerging markets.

AES Corp’s diversification will turn off investors looking for a pure play on energy storage. But unlike the overhyped Tesla Motors, AES Corp actually turns a profit and its stock still trades at an undemanding valuation that hasn’t priced in any upside from energy storage.

Tesla Motors’ management team doesn’t expect the company to turn a profit this decade. Nevertheless, the stock trades at an astronomical valuation of 9.3 times sales. AES Corp, on the other hand, sports a price-to-sales ratio of 0.6.

As for the rest of the utility sector, earning a fair return on investment by adopting new technologies intelligently and maintaining salutary relations with regulators remains the key to future upside.

The risks and opportunities outlined by the Brattle Group and other presenters at the EIA conference will help to determine which of the 214 names in our Utility Report Card will emerge as winners and which will lose out.