Powering On In The Face Of Uncertainty
For almost a century, investments in electric utilities have been the bedrock of low-risk income investors. Utilities have been seen as among the most highly secure of all investments, with slow but steady increases in dividends. Some utilities, known as “dividend kings,” have actually raised dividends every year for as many as fifty consecutive years. Part of the attraction of utility companies has been a steady increase in electricity demand, while investment in infrastructure has often been minimal. Today, these positive earnings factors may be changing.
Electricity sales growth in the United States has hovered around one percent since 2002, and energy use has actually declined in five of the past fifteen years, according to the Energy Information Administration. There are multiple reasons for the decline in demand, including higher efficiency standards, and new technology, including much more efficient home lighting. Other factors affecting demand include slower population growth, a decline in energy-intensive industries, and increasing reliance on digital controls and data analytics to reduce energy consumption; for instance, all sectors, from large manufacturers to individual consumers are monitoring heating and cooling equipment to optimize efficiency and lower consumption.
At the same time, environmental concerns are driving often radical change, most notably in the realm of renewable energy sources and distributed generation. Increasingly, individual home-owners are turning to roof-top solar panels for both economic reasons and concern for the environment; corporations are following suit, driven by economic and public-relations issues. This trend will only accelerate over the coming decade as renewable generation becomes cheaper and new battery technology begins to decrease and ultimately – perhaps in the next decade – virtually eliminate the chief limiting factor for renewables, intermittency.
These issues, combined with macro-economic trends will no doubt affect how utilities are viewed as long-term investments. For macro-economics, think interest rates. One of the main factors driving utility stock prices in recent years has been the very low interest rate environment. When interest rates were high – Treasury bonds were yielding as much as 14% thirty some-years ago – the risk premium that investors demanded from even very secure stocks, like utilities, was commensurately high. As rates fell, that risk premium declined, making these stocks even more attractive.
Now, however, there’s ample evidence that interest rates are likely to rise. The Federal Reserve predicts a rise of as much as 2.25% over the next few years, in which case long-term T-bills will become more attractive versus utility stocks. And if the Trump administration’s plan to offer even longer-term bonds, as long as 100 years, succeeds, the pressure could be even greater, since these extra-long-term bonds will offer extra-high dividends, putting further pressure on utility stocks. Higher rates also translate into higher costs of borrowing for utilities precisely when essential investment in infrastructure picks up.
Against the negative factors of stagnant demand and rising interest rates are a number of positive developments.
Utilities are increasingly partnering with customers to boost efficiency, limit the need for peak power and even delay and decrease the need to invest in new infrastructure through initiatives with programs often referred to as non-wire solutions. Con Edison in New York for instance, launched a pilot program, the Brooklyn-Queens Demand Management program, in which it is partnering with small businesses and individual customers. Under the program, Con Ed pays for the installation of smart devices to control both central air conditioners and individual window air conditioners which allow the utility to temporarily control air conditioning during peak summer hours. It is also paying small businesses to install efficient lighting systems. The company estimates that by cutting peak demand in this way it will be able to postpone building a new substation, at a cost of between $1- and $1.2 billion, for as long as ten years. That’s not to say Con Ed is actually saving all that money, and there is some debate about the actual savings involved, but there can be little doubt that enlisting customer cooperation in this way both cuts peak demand and lowers customers’ bills. This, in turn, helps the utility manage load and creates positive public relations for the company.
The industry is also enlisting customer involvement through smart technology – smart metering on the company side and the quickly burgeoning smart-home movement on the customer side – and through aggressive outreach programs. Customers benefit through lower bills and the companies benefit from being better able to manage demand and through a more positive impression, becoming a partner with customers rather than an indifferent commodity monopoly. Increasing utility transparency in regulatory and rate application affairs is helping to turn gray, non-descript corporate entities into more relatable service providers. How these initiatives actually affect how investors perceive utilities is an open question, but they can’t hurt.
The impact of today’s – and tomorrow’s – regulatory environment on how utilities are viewed as investments is perhaps the most difficult factor to assess. Will the Trump administration’s intention to deregulate carbon emissions, for instance, actually come to pass? Will states move to strictly limit greenhouse gas emissions regardless of federal regulations? What effect will the administration have in areas such as derivatives oversight and renewable energy tax credits?
Perhaps it’s just a romantic illusion to think of the past, any past, as a time of stability, but there can be no doubt that these are disruptive times for the utility industry. Rising interest rates, digital and data revolution, distributed generation, cyber-security insecurity. While all of these issues offer opportunities for growth, they also have the potential to seriously strain utility economics and, by extension, change the way investors view utilities. The security and reliability that so attracted a certain segment of investors seem to be disappearing, possibly easing the way for investors to view utilities in a whole new and exciting light.