Utility services play a vital role in a nation's economic progress
as cheap and abundant supply of power keeps the wheels of
development rolling. With development comes the need for more
power, as cities expand, and the use of new gadgets increases.
However, everything comes for a price. Greenhouse gas emitted by
large utilities cause immense damage to the environment.
Utilities have been under the scanner for a long time. However, the
recent climate action plan from President Obama, followed by the
U.S. Environmental Protection Agency's (EPA) proposal for granting
permission for setting up new power plants are putting immense
pressure on power producing units.
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 process. In addition, the
cost involved in implementing the latest requirement from the
environmental agencies could make power plants run on coal more
costly than before. This is compelling power generators to install
more eco-friendly power units and develop more power from renewable
As per a 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. The Asian market is expected to take
center stage in the global arena over the next four decades,
accounting for nearly 50% of global energy consumption by 2050.
In such a scenario, positive steps from the U.S. alone will not be
enough to counter the negative impact of global greenhouse gas
emissions. 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.
What is in the Climate Change Proposal?
The proposal from the EPA aims to strengthen the existing policies
on greenhouse gas emissions. Per the proposal, new large natural
gas-fired turbines would require to limit carbon emission of 1,000
pounds of CO2 per megawatt-hour, while new small natural gas-fired
turbines would need to meet a limit of 1,100 pounds of CO2 per
A new coal-based power plant will have to limit carbon emission to
1,100 pounds of CO2 per megawatt-hour. In addition, coal based
power generators would have the option to meet a somewhat tighter
limit if they opt for an average emission over multiple years.
The new recommendation will make electricity generation from coal
units far more costlier than before. Increasing awareness about the
pitfalls of coal-based power generation will drive regulators to
formulate even more stringent laws on emission from coal-fired
After this back to back announcement from the President and EPA,
most of the U.S. electric utilities that rely heavily on coal for
power generation will have to rethink their plant development
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 industries with Zacks
Industry Rank of #88 and lower is 'Positive,' between #89 and #176
is 'Neutral' and #177 and higher is 'Negative.'
Scanning the industries in the Utility sector, we find none in the
top 1/3rd. Gas Distribution and Water Supply both has a Zacks
Industry Rank #104, while Electric Power is at Zacks Industry Rank
Besides the Industry Rank, we also have ticker-wise rank allocation
for each ticker in our coverage universe. This indicates the
movement of the companies over a short timeframe (1 to 3 months).
We cover 77 electric utilities, out of which 11 tickers have a
Zacks Rank #2 (Buy), 48 tickers hold a Zacks Rank #3 (Hold) and the
remaining 18 tickers either have a Zacks Rank #4 (Sell) or a Zacks
Rank #5 (Strong Sell).
We track 25 gas utilities, out of which 7 tickers have a Zacks Rank
#2 (Buy), 12 tickers hold a Zacks Rank #3 (Hold) while 6 tickers
aren't doing well with a Zacks Rank #4 (Sell) or a Zacks Rank #5
We presently cover 12 water utilities, out of which 1 each have a
Zacks Rank #1 (Strong Buy) and Zacks Rank#2 (Buy), 8 tickers carry
a Zacks Rank #3 (Hold) and 2 tickers either have a Zacks Rank #4
(Sell) or Zacks Rank #5 (Strong Sell).
We would recommend investors to concentrate on Strong Buy, Buy or
Hold Ranked stocks. The reason is simple: the tickers with a Zacks
Rank #1 to 3 will have a higher probability to report strong
earnings results and outpace market expectation, compared to the
tickers in the bottom half having either a Zacks Rank #4 and 5.
The utilities on the whole reflected growth of 0.7% year over year
in the second quarter of 2013 compared to 3.1% registered by the
S&P 500 companies. As per the current standing, the utilities
are expected to improve upon their previous quarter's performance.
The utilities are expected to register a 2.4% year-over-year
increase in the third quarter, outpacing the S&P 500 beat of
0.5% over the same period.
The EIA reported 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
Alliant Energy Corporation
American Electric Power Inc.
Duke Energy Corp.
NextEra Energy Inc.
) among others.
Natural Gas Utilities
Among the utility services, natural gas usage is increasing due to
its abundance, cheap price and clean-burning nature. 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.
The positive dynamics are going to benefit natural gas utilities
AGL Resources Inc.
Atmos Energy Corporation
New Jersey Resources Corp.
Southwest Gas Corporation
MDU Resources Group Inc.
), among others. As per an EIA release, for the week ending Oct 9,
2013, U.S. natural gas hub prices grew moderately over the one-week
period. The Henry Hub spot price closed at $3.70 per million
British thermal units (MMBtu), on Oct 9, up 9 cents per MMBtu from
the beginning of the report week.
The recovery in natural gas prices will benefit the numerous
operators in the sector. 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.
In addition, the U.S. Department of Energy ("DOE") nod for LNG
exports will open up new market opportunity for the U.S. gas
utilities. In Sep 2013, electric and natural gas supplier Dominion
Resources Inc. (
) received an approval from the DOE to export 770 million cubic
feet of natural gas a day (mmcf/d) for 20 years.
The DOE is being cautious in granting permission for LNG exports.
At present 21 applications are pending with the regulator for LNG
export permission. Given the huge natural gas reserve in the U.S.
and ever increasing global demand for natural gas, the natural gas
export permission will help to unlock greater value of this natural
resource. This could be a potential game changer for the natural
The major challenge ahead for water utility operators is the aging
water and sewer infrastructure. Maintenance and development of
facilities play a crucial role and will test the financial
capabilities of the water utilities.
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.
Consolidated Water Co. Ltd.
) registered positive earnings surprises in their latest reported
quarters. The performance of these water utilities indicates that
these will register sequential growth in the third quarter of 2013
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.
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.
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.
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.
At the ongoing 22nd World Energy Congress in Daegu, South Korea,
the difficulties of providing sustainable energy to a growing
global population at a minimal environmental impact were debated.
In the same venue, World Energy Council released a note pointing
out the challenges resulting from population growth.
To sum up, a more prompt permission for LNG export will increase
the profitability of the U.S. natural gas operators. At the same
time a concerted effort will have to be made to remove the funding
requirement in the water utility sector. Otherwise the aging water
infrastructure will lead to more wastage, leading to a hike in cost
of operation and a related increase in the price of water supplied.
As for the electric utilities, these are venturing more and more
into grid scale solar and wind projects, wrenching the initiative
from the pure-play solar companies.
ATMOS ENERGY CP (ATO): Free Stock Analysis
AMER STATES WTR (AWR): Free Stock Analysis
CONN WATER SVC (CTWS): Free Stock Analysis
CONSOLTD WATER (CWCO): Free Stock Analysis
DOMINION RES VA (D): Free Stock Analysis Report
AGL RESOURCES (GAS): Free Stock Analysis Report
MDU RESOURCES (MDU): Free Stock Analysis Report
NEXTERA ENERGY (NEE): Free Stock Analysis
SEMPRA ENERGY (SRE): Free Stock Analysis Report
QUESTAR (STR): Free Stock Analysis Report
SOUTHWEST GAS (SWX): Free Stock Analysis Report
AQUA AMER INC (WTR): Free Stock Analysis Report
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