Premier Miton’s Jim Wright, Fund Manager of the Premier Miton Global Infrastructure Income Fund, shares the three reasons behind electricity demand growth in the USA, and why they are long term trends, rather than short term impacts.
The “Silver Bullet”
Can US regulated utilities establish themselves as growth stocks, and break the correlation with interest rates, which has seen the sector underperform the wider market at times when bond yields are rising? Is electricity demand from artificial intelligence data centers the “silver bullet” which transforms the sector, like air-conditioning in the 1960s? Or is the bull case more about steady growth in underlying electricity demand? And will the regulators (boo!) find a way to destroy the growth story, and send the sector back to stock-market obscurity? OK, this might not be the best idea for a crowd-pulling movie, but this theme is front and centre for infrastructure investors in 2025, and beyond…
In the Premier Miton infrastructure team we love a bit of history, and always try to use a historical perspective as a lens through which to view the present, and the future, to better understand trends and developments in the sector and in equity markets. And in fact, the dull, boring US utility sector has not always been so – in the past electricity demand has been a huge engine of growth for the sector.
Source: US Energy Information Administration
As the chart shows, electricity demand growth in the USA compounded at over 8% every year through the 1950s and at over 7% every year through the 1960s. By 1970 demand was 4½ times higher than in 1950. Industrial and manufacturing growth and the widespread adoption of household appliances were important drivers, but the key development was air conditioning. It is no exaggeration to say that the growth of the Southern USA as we know it was built on twin pillars in the 1960s – civil rights legislation and air conditioning. Growth then tapered down until the 2010s, and demand for electricity actually fell between 2010 and 2020. In essence there were two reasons for this. One was unambiguously good – energy efficiency, in terms of conscious efforts to reduce consumption and from technological innovations which reduced the electricity consumption of almost every device which used electric power. The other was offshoring – the apparent benefits of globalisation enabling US manufacturers and industrial producers to move production out of the USA into lower-cost geographies to improve profitability.
It is this context, with no underlying demand growth, which has led to US electricity utilities being viewed as “bond proxies” between the global financial crisis of 2007-2008 and the recent pandemic. There has been growth in their asset bases, as old and fully depreciated coal-fired power plants have been replaced by renewable generation assets, as transmission lines have been built to hook these wind and solar power sources up to the grid, and as replacement, storm-hardening and wildfire prevention investments have been made to reinforce networks. But this was pedestrian, low-single digit growth, and so the stocks have been increasingly valued on their defensive qualities and their dividend income stream relative to bonds.
What’s changed? Three reasons for long-term growth
But we are now at a turning point. Electricity demand in the US has started to grow, and power prices are rising. Reserve margins (the excess of reliable supply over demand) have tightened, and the merchant power generation stocks have been among the leading S&P 500 Index performers in 2024. So why has this happened, and can it be sustained? And can the regulated utilities break the correlation with interest rates, and benefit from this renewed demand growth.
There are basically three reasons why electricity demand has begun to grow in the USA, and we see all three as long-term trends rather than simply having a short-term impact. The first is electrification – the replacement of other forms of energy with electricity. Most notably this includes electric vehicles, including passenger cars and also buses and heavy trucks. As charging networks are built out, the penetration of these vehicles in the USA will grow, driving (no pun intended) increased demand for electricity. Secondly, there has been a notable reversal of the offshoring trend discussed above. A combination of politics – “America First” and the trade wars with China – and the impact of the pandemic, when many US businesses discovered that multinational supply chains were unexpectedly fragile, has resulted in the repudiation of globalisation and increased domestic investment in manufacturing and heavy industry. These facilities are huge consumers of energy, including electricity, and we have seen demand forecasts steadily rise as a result.
The third reason for the forecast growth in electricity consumption is that referred to above as the potential “silver bullet”, which might have the same impact as air-conditioning in the 1960s – the growth in data centers to facilitate Artificial Intelligence applications. Much has been written on this theme, and we are wary of getting swept along with the tide and becoming over-optimistic in our forecasts. However, this trend is real, and we have seen Microsoft, Amazon and other major players already commit to significant long-term contracts to secure electricity for their own planned data center expansion.
In the introductory paragraph we raised the possibility that the industry regulators (the state Public Utility Commissions and the Federal Energy Regulatory Commission) might derail the equity story for regulated utilities. We believe that this is an area where we can add value to investors, by constantly monitoring which states have a constructive regulatory outlook, and which are likely to undermine utility growth, often due to a political agenda. Currently we would avoid Connecticut, Oregon, New York and Illinois, whereas we are very comfortable to own stocks with assets regulated in New Jersey, Texas, Florida and Indiana.
Blockbuster returns
Overall we enter 2025 with a very positive long-term view on US electricity demand, and whilst being selective in terms of stocks and mindful of local regulation, we see the outlook for regulated utilities as very favourable. It is clear that investment is needed in generation, transmission and distribution assets to meet the growing need for power and given a sensible regulatory backdrop, this asset growth has the ability to translate into growth in company valuations, in earnings and in dividends for investors. And, importantly, we believe that this can happen even in an environment where interest rates are rising, breaking the correlation with bond yields and providing blockbuster returns for equity investors.
Jim Wright
Fund Manager, Premier Miton Global Infrastructure Income Fund