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Will Utility Stocks Become "Less Boring" In the Future?

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With less than a week to go before America decides its next president, the stock market is shifting gears. Corporate developments have become less important in determining price swings than the policy positions staked out by the two main parties. For investors in utility stocks, these proposals are especially important because they will determine the industry’s future course at a pivotal time. The key question for them is how these elections will affect future stock prices for the sector.

A Less Boring Sector?

The Wall Street Journal recently published a piece about utility stocks claiming that they would become a “little less boring” in the coming years. “The global focus on climate change is shaking up the industry and the presidential election could shake it up even more,” the publication writes and questions whether investors will be willing to stick with utilities as they continue to go through “wrenching changes”. The changes referred to here are the impending shifts in business models for utilities in a decentralized grid powered by renewable energy. In turn, a shift in business operations could have profound implications for the priorities of utility stocks, from being an instrument for dividends to aggressively seeking out profits.

For investors, utility stocks are generally defensive plays that generate a steady stream of income for investors. The percentage dividends offered by the stocks is better than that offered by government securities and, in certain cases, be more frequent.

However, in a year when most certainties have turned topsy-turvy, utility stocks have lagged the overall performance of the S&P 500 index. Before the general economic turmoil caused by the pandemic, several utilities had publicly declared their intentions to eliminate fossil fuels from their energy mix and decarbonize operations. But the pandemic has saddled them with a pile of unpaid electric bills to add to their growing debt from issuing bonds.

To make the transition to becoming a “less boring” sector, utilities will need the assist of policy proposals that help them pad their bottom line with new sources of revenue. The incoming administration’s policies could have an important impact on their balance sheet and, in turn, their valuations. During a time of static or decreasing demand from residential customers, electrification of transportation and buildings offers a possible profit center. Rob Gramlich from Grid Strategies LLC estimates that it could result in a fifty percent increase in demand for electricity. But reaching that figure is possible only with sufficient innovation and investment and a reworking of transmission frameworks.  

Democrat nominee Joe Biden, who seems to be ahead in most polls, plans to invest $2 trillion over the next four years towards climate change. He has set an ambitious timeline for decarbonizing the electric grid by 2035. That target stands in contrast to the more measured approach of utilities targeting a complete shift away from carbon by 2050. Most commentators have said it is unrealistic. For example, U.S. Energy Secretary Ernest Moniz says reaching the goal is possible only if this decade is a “supercharged innovation decade”. 

Still, a Biden presidency will bring good tidings for utility stocks. He has proposed an extension of tax credits for developers of renewable energy sources. That should boost their production and, more importantly, make them cost-competitive with fossil fuel sources to enable utilities to reach their renewable energy targets. According to the latest EIA numbers, natural gas remains the dominant source for generating electricity. Biden’s double-speak on the fuel – he intends to phase out fracking “over time” but still wants to decarbonize the grid in 15 years – will ensure that natural gas has a role to play even as renewable energy ramps up in the grid. For publicly-listed utilities, such as Duke Energy, that depend on fossil fuels for a bulk of their electricity generation, Biden’s statements are good news because it buys them time to make the shift to renewable energy sources.

More of The Same

Wall Street is pleased with the Biden-Harris energy plan and the possibility of future growth. The WSJ piece quotes Rob Thummel, senior portfolio manager at Tortoise Capital, as saying that there’s more “potential for growth than there has been.” In recent times, the Street has become enamored with future growth potential. Witness the surge in technology stock valuations during the pandemic. But utility stocks may not witness a similar influx of funds because of regulatory restrictions and the impossibility of implementing sudden pivots to their business models. But their balance sheet remains solid, a testament to conservative cash management and restricted revenue growth, and their stock prices trade at a discount to the overall valuation. And, despite being kneecapped by the pandemic shutdown, utilities have kept their dividend commitments. The chances that this state of affairs will spiral into aggrssive growth after the economy reopens remains dim. In other words, despite Biden’s aggressive timelines, it might be some time before utility stocks become “less boring”.

Discussions

Bob Meinetz's picture
Bob Meinetz on Oct 31, 2020

Rakesh, utility stocks were very exciting in the 1920s, when cash-rich Edison Electric Corp. invested $millions in junk bonds and speculative equities, then lost it all in Great Crash of 1929 and their customers' lights went out. That was a thrill a minute, I'm sure.

Then FDR came along and decided access to electricity was a fundamental human right. Instead of being able to raise rates indiscriminately and bribe politicians to let them get away with it, utilities were forced to only engage in business that was "in the public interest". They were forced to build transmission out to farmers in rural areas, not because poor farmers could pay for it, but because electricity was a fundamental human right.

That was when things got boring. No more corruption, no more exploitation, no more get-rich-quick schemes. Just reliable, dependable electricity that paid steady returns to investors year-after-year. That, of course, was the point. Now, with FDR's legislation only a fond memory, not only is my ultra-special super-renewable electricity 30% more expensive than it was ten years ago, it's less reliable.

I wonder how many customers would be willing to forego the "supercharged innovation decade" for reliable, boring electricity that was 30% cheaper. Me, I'd be first in line.

Rakesh  Sharma's picture
Rakesh Sharma on Nov 2, 2020

Bob, did you invest in utility stocks during the 1920s? 

Bob Meinetz's picture
Bob Meinetz on Nov 3, 2020

No Rakesh, I'm jaded but probably not as old as I sound.

I am familiar with the history of utility electricity though, and have always tried to believe humanity was capable of learning from its mistakes. Instead, I find each generation is forced to learn the same lessons of human nature anew.

In the 1960s, there were hopes society was progressing on a road to racial equality; now it's like the sixties never happened.

In the 1930s, there were hopes access to electricity was recognized not as a profit center but as a fundamental human right, and that a compromise could be worked out between profit and public interest. A successful compromise was discovered - then 70 years later, "un-discovered".

The challenge of abundant, affordable, clean electricity is not that difficult or expensive - that's its problem. By meeting the challenge efficiently there's less consumption and less profit. So stupid, deliberately-inefficient ways to generate electricity are invented so profiteers have something to sell. Kind of like quack cures for cancer - if people want something bad enough, they'll believe pretty much anything they're told.

Rakesh  Sharma's picture
Rakesh Sharma on Nov 4, 2020

Thanks for your reply, Bob. I suppose the economics of "un-discovery" are more related to profit than invention or efficiency. You are not the only one who is jaded.   

Rakesh  Sharma's picture

Thank Rakesh for the Post!

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