The increasing demand for utility services, particularly for
electricity, is leading to the installation of large generation
units. The power generators, in the wake of more stringent
environmental regulations and restrictions, are gradually shifting
their focus to renewable sources and natural gas to produce power.
This is a welcome sign for the industry and a positive step towards
reducing the emission of greenhouse gases.
The utility operators are implementing new technologies in
generation and distribution of power. The introduction of smart
meters will benefit customers while the smart-grid technology is
likely to increase efficiency. However, implementation of these new
technologies, over vast service territories, is a long, drawn-out
Utilities are by their very nature monopolistic businesses. As a
result, the sector is highly regulated as the essential supplies
cater to basic human needs, and governments try to ensure the
prices of these supplies -- water, electricity, etc. -- stay within
reasonable limits. The utilities, on the other hand, try to
increase prices through the filing of rate cases. The investments
and costs incurred for the modernization and maintenance of
reliable services are recovered through these rate cases.
As per a recent U.S. Energy Information Administration (EIA)
report, global energy use will increase to 770 quadrillion Btu in
2035 from 505 quadrillion Btu in 2008. The majority of this usage
is expected to come from countries outside the Organization for
Economic Cooperation and Development (non-OECD nations). The energy
market of non-OECD nations has a larger scope for improvement
compared to the more mature OECD nations.
However, the addition of new power-generating units to meet the
increasing demand for electricity comes the pertinent question of
greenhouse gas emission. We are all aware of the pitfalls of global
warming and initiatives are been taken to curb the release of
greenhouse gas. The U.S. and European countries are taking serious
strides in that direction.
However, the variance in the socio-economic structure of
different countries and the quest for cheaper sources of
electricity are making the task difficult, if not impossible. In
fact, a recent study from International Energy Agency showed that
the greenhouse gas emitted from China in 2012 offset the positive
impact of lower emission from Europe and the U.S.
China has very recently adopted 10 measures to improve air quality
and reduce emission in Beijing and in other major cities. Whether
the promise will be kept time will tell.
The demand for utility services is primarily driven by the state of
the economy. If the economy is doing well, it will create new jobs,
resulting in demand for housing driving demand for utility
services. In addition to growing demand through households,
increasing demand from the business sector, particularly
manufacturing, also plays a role in growth.
Weather plays a crucial role in determining the trajectory of
demand for utility services. Extreme weather conditions tend to
reinvigorate demand for electricity.
Population does play a significant role in demand creation. The
gadgets we use every day consume considerable electricity. This
issue is prevalent all over the world, but it is particularly
notable in the emerging markets where huge swathes of population
are entering the middle class.
The billions of cell phones, personal computers and laptops have
increased the demand for electricity, which could have hardly been
imagined only a decade ago. The clothes dryer, clothes iron and
dish washers are a few among the numerous household appliances
which consumes a considerable amount of electricity.
Ultimately, it all boils down to economic growth, as measured by
Gross Domestic Product (GDP). As per the recent report of the
Bureau of Economic Analysis, U.S. Department of Commerce, GDP
increased 2.4% in the first quarter of 2013, compared with an
increase of 0.4% in the fourth quarter of 2012. This is definitely
a positive sign for the utility industry, as a portion of the
increase will be directed toward household utility needs.
Within the Zacks Industry classification, Utilities are a
stand-alone sector, one of 16 Zacks sectors. The rural wire-line
telephone companies are also grouped within the Zacks Utility
sector, but the three major industries within this sector include
Electric Power, Gas Distribution and Water Supply.
The Utility sector's defensive attributes reflect the group's
lack of correlation with the broader market/economy. Of course, the
sector's reputation as a dividend payer also adds to its perceived
We rank all of the more than 260 industries in the 16 Zacks sectors
based on the earnings outlook for the constituent companies in each
industry. This ranking is available in the Zacks Industry Rank.
The way to look at the complete list of Zacks Industry Rank for the
260+ industries is that the outlook for the top one-third of the
list (Zacks Industry Rank of #85 and lower) is positive, while the
outlook for the bottom one-third (Zacks Industry Rank #170 and
higher) is negative.
Scanning the industries in the Utility sector, all three are
currently ranked in the top 1/3rd. Gas Distribution has a Zacks
Industry Rank #45, Electric Power is at Zacks Industry Rank #83 and
Water Supply at Zacks Industry Rank #76. This implies that the
prospects for gas, electricity and water look bullish at present.
The EIA reports that electricity consumption in the U.S. will
increase from 3,841 billion kilowatt hours in 2011 to 4,930 billion
kilowatt hours in 2040, increasing at an average annual rate of
0.9%. For the fuel type in energy generation, renewables and
natural gas will play an increasing role while coal and nuclear
power will gradually fall out of favor.
As per EIA, the increasing demand for electricity and retirement of
nearly 103 gigawatts (GW) of existing capacity will result in an
addition of 340 GW of power production units from 2012 to 2040.
Natural gas-fired plants will provide 63% of the projected
capacity, while 31% will come from renewables, 3% from coal and 3%
from nuclear. This proves that natural gas will continue to play a
vital role in energy solutions in the coming three decades.
The electric utilities expected to play an important role in
meeting this increased demand for power are
American Electric Power Inc.
Duke Energy Corp.
NextEra Energy Inc.
), among others.
We expect electricity providers to continue to perform well in 2013
with the majority expected to exceed 2012 earnings numbers. A
near-normal winter to start of and expectation of above-average
summer temperatures in the US will definitely boost the demand for
Natural Gas Utilities
Among the utility services, natural gas usage is increasing due to
its abundance, cheap price and clean-burning nature.
However, natural gas prices are recovering from all-time lows. This
might hamper the rising demand curve for natural gas in the near
term. Over the long haul, we believe the demand for nat gas will
pick up once more.
The EIA forecasts the use of natural gas in the U.S. to increase
from 24.37 trillion cubic feet in 2011 to 29.54 trillion cubic feet
in 2040, increasing at an average annual rate of 0.7%.
New fracking technology has multiplied natural gas production from
rock and rock structures previously considered uncommercial.
A study from NaturalGas.org pointed out that the natural gas
reserve in the U.S. increased by 39% from 2006 levels, thanks to
the implementation of new exploration techniques.
The natural gas utilities are not only expected to benefit from the
steady increase in domestic demand but also from exports that are
expected to rise significantly. The new techniques used to drill
natural gas will enable natural gas operators to export large
volumes after meeting domestic demand. As per the EIA, natural gas
exports will continue to increase by 17.7% per year from 2020 to
The positive dynamics are going to benefit natural gas utilities
tmos Energy Corporation
Spectra Energy Corp.
National Fuel Gas Company
MDU Resources Group Inc.
Southwestern Energy Co.
), among others. With more than 71 million domestic natural gas
customers, the industry has enough room for nearly 1,200 natural
gas utilities presently operating in the country.
2012 was a good year for the water utilities as the overall warm
weather increased the demand for water. However, the major
challenge ahead of the water utility operators is the aging water
and sewer infrastructure. Maintenance and development of facilities
play a key role and will test the financial capabilities of the
A report from Economic Development Research Group Inc. suggests an
alarming gap between the water infrastructural requirement and
actual investments planned for the coming years. The gap is
expected to reach $84 billion in 2020 and widen to $144 billion in
2040. The report also revealed that without proper renewal or
replacement, nearly 44% of the existing pipelines will become too
poor for operation by 2020.
The utility operators have begun to invest in their ageing
infrastructure, but it appears the initiatives are inadequate to
bridge the gap. The government should consider taking adequate
measures before things blow out of proportion.
Among the water utilities,
American States Water Company
Aqua America, Inc.
Connecticut Water Service, Inc.
Middlesex Water Company
) registered positive earnings surprises in their latest reported
We expect the water utilities on the whole to perform better than
last year, driven by higher demand.
What Keeps the Utilities Going?
The biggest positive for the utilities is that there is hardly any
viable substitute for utility services. This is the most
fundamental strength of the industry. Moreover, increasing demand
drives this industry forward.
As per the EIA, energy usage in the U.S. industrial sector will
increase from 24.0 quadrillion British thermal units (Btu) in 2011
to 28.7 quadrillion Btu in 2040. In the commercial sector,
consumption will increase from 8.6 quadrillion Btu in 2011 to 10.2
quadrillion Btu in 2040. In the transportation sector, demand will
hover around 27.1 quadrillion Btu from 2011 through 2040.
The utility operators in North America often resort to merger and
acquisitions or enter into partnerships, which lead to cost
synergies and better utilization of resources. As per a report from
PricewaterhouseCoopers, utility M&A deals valued at more than
$50 million added up to $2.99 billion in the first quarter of 2013.
A recent announcement from MidAmerican Energy Holdings Company, a
Berkshire Hathaway Inc.
), to acquire
) in a way exceeded the combined value of all merger deals
announced in the first quarter of 2013. The transaction, which has
been unanimously approved by the board of directors of both
companies, has an enterprise value of approximately $10 billion.
The deal is expected to close in the first quarter of 2014, subject
to regulatory approvals and approval of shareholders of NV Energy.
We believe the synergies of merger and decline in overlapping
overhead operating expenses could allow the companies to
concentrate more on the development and maintenance of
Another inherent advantage of these utilities is their size and the
requirement of huge initial capital outlay. For this reason,
we generally do not find many new entrants in the market. Also,
stringent government regulations and the hard toil for new entrants
to establish a loyal consumer base put existing players in an
Finally, utilities have been known to pay dividends consistently,
thereby retaining investor confidence. This was evident during the
economic crisis of 2008-2009 when these operators continued to pay
out dividends without fail.
The Future of Utilities
Undoubtedly, the focus and emphasis to generate power from
renewable sources have increased. But will this pose a threat to
the more traditional power producers using fossil fuels? The answer
is largely "no," at least for now.
Having said that, the gap between these two groups of power
generators will continue to shrink as we move forward. Eventually,
renewable power producers may overtake traditional electric
utilities in due course.
The Middle East has the largest volume of fossil fuel reserves.
Even there we are noticing a large number of solar power projects
coming up in the region. An EIA report suggests that by 2040 nearly
20% of the total power produced will come from renewable sources.
Solar generation capacity is expected to increase by a whopping
1000% to 46 GW in 2040 from 2011 levels.
We are all aware of the pitfalls of greenhouse gas emissions and
the limited life of fossil fuel. In addition, the increasing
conversion rate of solar cells makes it cheaper and cost effective
in comparison to conventional sources. Renewables can thus be the
final answer for the inevitable exhaustion of fossil fuel reserves.
Despite the assured demand for services, the utilities have to
constantly meet the high expectations of its wide customer base,
adapt to a changing global economic scenario, and upgrade
technologies to meet stringent environmental norms.
Utility operations globally depend on weather patterns that
determine the extent of demand. Erratic weather patterns thereby
impact the profitability of these operators, so much so that their
operational goals remain unmet.
Moreover, hurricanes, storms, and blizzards disrupt the normal
operation of the utility operators. American weather tracking body
National Oceanic and Atmospheric Administration ("NOAA") has
projected a very active hurricane season in the second half of
2013, and storms are expected to exceed the seasonal averages. With
the havoc caused by Superstorm Sandy still fresh in our memory, we
are keeping a cautious eye on Mother Nature.
The majority of new electricity in the next two decades in the U.S.
will be generated from natural gas and renewable sources. Besides
the abundance of natural gas, as many as 30 U.S. states and the
District of Columbia have enforceable renewable portfolio standards
or other renewable generation policies. We expect this count to go
up, compelling producers to generate more green power to meet the
renewable standards fixed by the states.
Since the utilities operate in a regulated environment, they charge
a fixed rate for power supply as approved by the different
commissions. We hardly find utilities posting eye-catching numbers,
but these companies are generally stable due to the regulated
nature of operations, and they are loyal to shareholders.
Investment in the utility sector is more suited for
income-oriented, long-term investors looking for a modest but
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