Utility services undoubtedly play a major 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 at a price, as green-house gases emitted
by large utilities cause irrevocable damage to the environment.
The utilities have been under review for a long time. The climate
action plan of the U.S. President followed by the U.S.
Environmental Protection Agency's (EPA) proposal for tightening the
rules to set up new power plants are putting immense pressure on
power producing units.
Utilities are now gradually shifting their emphasis towards natural
gas and alternate energy sources to produce power. Global concerns
about the pitfalls of green-house gas emissions supported by
increasingly stringent government regulations have brought
alternative energy into the limelight.
In such a scenario, progressive steps from the U.S. alone will not
be enough to counter the negative impact of global greenhouse gas
emissions. The disparity 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, increasing emission from the developing nations is
undermining the positive steps taken in the U.S. and Europe to curb
While fossil fuel is the predominant source of generating power in
the U.S. renewable and alternate energy sources are gradually
making inroads into this dominance. Per a U.S. Energy Information
Administration (EIA) report, U.S. energy demand totaled 97.5
quadrillion British thermal units (quads) in 2013 out of which 81.7
quads or 84% were produced domestically. Out of the total energy
consumed in the U.S. in 2013, 82% were from fossil fuel, as per
The EIA report indicates that the total energy use in the U.S. will
increase to 106.3 quadrillion Btu in 2040 from 95 quadrillion Btu
in 2012. Most of this demand is expected to come from the
Industrial sector followed by the Commercial sector.
Presently, the country is working towards attaining energy
independence. Hence, the utilities have scope to increase their
production volumes to meet rising demand and help the nation
achieve its goals.
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, three prominent
industries under this sector are currently ranked in the top
category. Electric Power is at a Zacks Industry Rank #28, Gas
Distribution has a Zacks Industry Rank #38, while Water Supply has
a Zacks Industry Rank #69.
In the first quarter of 2014, total earnings for the Utility sector
were up 18.0% on 11.2% higher revenues. The sector's strong
earnings performance makes sense as they were the primary
beneficiaries of the quarter's frigid weather. The majority of
utilities benefitted from dropping mercury levels in their service
For 2014 and 2015, earnings from this sector are expected to
increase at rates of 10.0% and 4.9% year over year. In 2014, the
Utility sector is expected to surpass the S&P 500 growth of
6.8% but lag the 2015 projection of 11.5%.
For more information about earnings for this sector and others,
please read our
'Earnings Trends' report
The EIA reported that electricity consumption in the U.S. will
increase from 3,826 billion kilowatt hours in 2012 to 4,954 billion
kilowatt hours in 2040, implying an average annual rise of 0.9%.
For the fuel type in energy generation, renewables and natural gas
will play an increasing role while coal will gradually fall out of
The EPA has proposed a new plan to curb pollution from domestic
power plants. The objective is to reduce emissions by 30% by 2030
from 2005 levels. If these proposals go into effect, electric
utilities relying primarily on coal and without adequate retrofit
to scale down the carbon footprint will be the worst affected.
An EIA report indicates coal-fired power generation to drop from
310 gigawatts (GW) in 2012 to 262 GW in 2040. The decline is a
function of greater dependence on natural gas, usage of alternate
energy sources and stricter regulations. The utility operators are
implementing new technologies for the generation and distribution
of power. The introduction of smart meters will benefit customers
while the smart-grid technology is likely to increase efficiency.
The important electric utilities that play a vital role in meeting
the demand for power are
American Electric Power Inc.
NRG Energy Inc.
Duke Energy Corp.
NextEra Energy Inc.
Dominion Resources, Inc.
) among others.
Among the 74 electric utilities in our coverage, 9 stocks sport a
Zacks Rank #1 (Strong Buy), 17 stocks have a Zacks Rank #2 (Buy),
41 stocks hold a Zacks Rank #3 (Hold) and the remaining 7 stocks
have either a Zacks Rank #4 (Sell) or a Zacks Rank #5 (Strong
Natural Gas Utilities
The country has huge volumes of natural gas reserves and the new
fracking technology has multiplied natural gas production from rock
and rock structures previously considered uncommercial. The wide
availability, its clean burning nature added to stringent
government regulations to curb pollution make natural gas a
favorable choice for electricity production as well as for other
industrial and commercial usage.
An EIA report shows that natural gas will become the largest source
of electricity generation in the U.S. by 2035 and will topple coal
in the process. The EIA forecasts the use of natural gas in the
U.S. to increase from 25.6 trillion cubic feet ("Tcf") in 20112 to
31.6 Tcf in 2040.
These positive dynamics are going to benefit natural gas utilities
AGL Resources Inc.
Atmos Energy Corporation
WGL Holdings Inc.
National Fuel Gas Company
New Jersey Resources Corp.
MDU Resources Group Inc.
) among others.
Multi-fuel producer CONSOL Energy Inc. (
) has shifted its focus on natural gas and has thus divested a few
of its coal assets. CONSOL Energy's emphasis on natural gas assets
has started to yield results and the company's earnings in first
quarter 2014 surpassed the Street expectation by a wide margin.
Buoyed by this success, the company aims to increase its natural
gas production by 30% over the next couple of years.
The U.S. is presently working towards gaining energy independence
and, as per a report from the EIA, it will become a net exporter of
natural gas by 2020, after meeting domestic demand. So, from a net
importer of 1.5 Tcf of natural gas in 2012, the U.S. will likely be
a net exporter of 5.8 Tcf in 2040.
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.
Given the abundance of natural gas in the U.S., after much
deliberation, the U.S. Department of Energy (DOE) has granted
permission to export liquefied natural gas (LNG). To date, DOE
received 31 applications from natural gas producers to export gas.
Seven U.S. projects have until now received approval from the DOE
to export gas. The facilities also need to secure approval from the
Federal Energy Regulatory Commission (FERC) before exporting gas.
Cheniere Energy, Inc.
) received all necessary permits and approval to export natural gas
from its Sabine Pass site.
We believe this decision will allow U.S. nat gas producers to
channelize their production volumes (after meeting domestic demand)
to feed the ever increasing appetite for power in the global
We track 24 gas utilities, of which 1 stock has a Zacks Rank #1
(Strong Buy), 7 stocks have a Zacks Rank #2 (Buy), 14 stocks hold a
Zacks Rank #3 (Hold) while 2 stocks have a Zacks Rank #4 (Sell).
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 these 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.
Since the water utility industry is highly fragmented it poses a
serious challenge in meeting infrastructural requirements.
Presently, there are nearly 53,000 water system operators in the
U.S. (as per American Water Works). This in a way stops them from
enjoying economies of scale and pass the same to their consumers.
Presently, the top operators in this space have started to make
strategic acquisitions to expand and consolidate operations.
A prominent water utility, American Water Works Company, Inc. (
) has lately resorted to the inorganic route to expand its
footprint. We view this as a smart move as larger companies will
likely have better provisions to address the infrastructure needs
of this industry.
Other top operators in the water utility space have also fallen
back on acquisitions. Apart from American Water Works, its peers
Consolidated Water Co. Ltd.
Connecticut Water Service Inc.
Aqua America Inc.
) utilized inorganic strategies to enhance their scale of
We presently cover 11 water utilities, of which 2 have a Zacks Rank
#2 (Buy), while the rest have a Zacks Rank #3 (Hold). Five out of
the 11 water utilities we track registered a positive earnings
surprise in the last quarter.
What Keeps the Utilities Rolling?
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 barrier to entry 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 advantageous position.
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. In fact, new
technology to produce power at a cheaper rate and emerging
alternative resources for the generation of green power is likely
to drive the industry going forward.
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 29 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.
Fuel cell technology, an alternate method of power generation, has
been making a lot of buzz lately. We, however, admit that this
technology has a long way to go if it were to provide power plant
solution on a large scale. The lead players in this field engrossed
in R&D are
Ballard Power Systems
Plug Power Inc.
). For now, it is a wait and see situation to find out whether fuel
cell can offer a realistic solution to power generation and
greenhouse gas emissions or whether its potential is only good on
All said, utility operations globally depend on weather patterns
that determine the extent of demand. The frigid weather in the U.S.
during the last winter season showed how dependent we are on these
utilities for basic needs.
To sum up, LNG exports will increase the profitability of the U.S.
natural gas operators but the bottlenecks in granting permission
are a concern. 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, we expect more investment in natural
gas and alternate energy projects, wrenching the initiative from
the pure-play coal based electricity companies.
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