There are many good reasons to invest in utilities. They are recession-proof. The dividends are attractive. They are regulated and dependable.
But is the rise of artificial intelligence, which relies on vast quantities of electricity required by data centres, now emerging as the chief reason to invest in the sector?
You might come to this conclusion given the stunning rally – well, by utilities standards – of the past three months.
U.S. utilities within the S&P 500 have gained 15 per cent over this period, by far the best-performing sector. By comparison, tech stocks are up 8.6 per cent over this three-month period.
Sure, we can insert all sorts of asterisks here. Tech stocks have easily outperformed utilities over other periods, such as the past year. For all the new-found attention, U.S. utilities are still nearly 10 per cent below their highs in 2022.
The recent gains are mysteriously absent in other regions, too, such as Canada. Here, utilities within the S&P/TSX Composite Index are up less than 3 per cent over the past three months.
Lastly, U.S. economic activity subsided to just 1.3 per cent in the first quarter, at an annualized pace, down from 3.4 per cent in the fourth quarter of 2023. Subsiding economic growth makes defensive stocks, such as utilities, look comparatively attractive. And it could lead the way to central bank interest rate cuts, which should lift the fortunes of dividend-paying stocks.
Asterisks aside, though, it’s hard to ignore the influence of AI, an investing theme that has been dominating the stock market for about a year and pushing investors to consider other potential winners beyond the likes of chip maker Nvidia Corp. NVDA-Q
While utilities may seem like a stretch at first glance, the connection between AI and electricity demand is real.
“Data centers are and will continue to be a significant source of demand,” said Suparna Ray, an energy analyst at the U.S. Energy Information Administration (EIA), in an e-mail.
In its first-quarter financial results, Ohio-based American Electric Power Co. Inc. noted that the 10.5-per-cent year-over-year increase in commercial power demand was driven by data centres.
As more companies tap into the productivity-enhancing promise of AI, electricity demand will rise further. According to Rystad Energy, the global research and analysis firm, data centres and chip factories consumed 3.5 per cent of total U.S. power in 2023.
But Rystad expects this share will rise at a compound annual growth rate of 13 per cent through 2030, which will require significant investments in the U.S. electricity grid.
“The grid in the U.S. is in much dire need of upgrades and new investment to serve the growing demand for electricity,” said Mohammed Hamdaoui, vice-president of power markets research at Rystad, in an e-mail.
For utilities stocks, it’s hard to imagine a better long-term scenario. But there could be some bumps along the way.
For starters, not all utilities stocks are likely to meet lofty expectations. While the U.S. sector, as a whole, has been strong over the past few months, there is a disparity among individual names within the sector.
Texas-based Vistra Corp. VST-N, which has nuclear and solar power among its assets, along with battery storage capabilities, is one of the clear winners. Its share price has rallied 91 per cent over the past three months, partly on upbeat expectations for data centres. The stock joined the S&P 500 in early May.
Other utilities are meandering, though. Although Dominion Energy Inc. D-N expects energy demands from data centres in Virginia will rise more than 10 per cent annually over the next 15 years, its share price is down 38 per cent from recent highs in 2022. This suggests that the dampening effect of high interest rates might be outmuscling the promise of AI.
Secondly, the expansion of data centres may conflict with energy-saving goals related to combatting climate change. That could lead to regulatory pushback or perhaps something that momentum-chasing investors aren’t counting on: energy-saving technology and greater efficiency – say, through enhanced cooling systems and by shifting computing tasks to off-peak hours.
The big hope for investors is that U.S. electricity usage will embark upon another profound burst, like the one that began after 1950.
But investors who prefer their utilities dull and predictable should also consider this: Although electricity consumption is up 14-fold over the past seven decades, according to the EIA, it has essentially flatlined since 2007, thanks to big gains in efficiency standards.
The promise of AI is alluring. But perhaps dull stability, rather than exciting growth, is still what makes utilities attractive over the long term.