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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. 

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The Market's Sleepiest Sector Becomes Top Winner of the AI Boom

  • The surge in artificial intelligence technology has created a most unlikely winner on the stock market.
  • Utilities have typically been a defensive stock play as they offer consistent and stable returns even in recessions as revenues from supplying customers with electricity and water are stable and secure in downturns.
  • Electric utilities have seen a marked change in their stock market performance as a growing number of investors see these companies as big winners in the AI-driven surge in power demand
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The surge in artificial intelligence technology has created a most unlikely winner on the stock market.  

Electric utilities, the ones that will meet the soaring demand to power data centers and generative AI, have turned from the sleepiest steady stock investment on the market into the hottest bet on the AI boom.

Following the worst market performance in more than two decades in 2023, the utilities sector is shining on Wall Street this year in a dramatic shift of sentiment and share price gains as investors are betting on the companies that will power the future of AI.

Utilities Shine

Utilities have typically been a defensive stock play as they offer consistent and stable returns even in recessions as revenues from supplying customers with electricity and water are stable and secure in downturns, too—everyone needs the services these companies provide.

The flip side of utility stocks is that they don't soar in times of booming economy. They are also suffering in a high-interest rate environment like the current one as investors chase higher-yielding alternatives such as Treasury yields as interest rates rise.

As the low interest rate environment ended when the Fed began raising the rates, utilities – whose dividends earned more than the 10-year Treasury yield at near-zero interest rates – fell out of favor.

Related: Why Oil May Regain Upward Momentum

Last year, as interest rates were rising, the Dow Jones Utility Index dropped by 7.2% while the S&P 500 index jumped by 26.3%. This was the worst underperformance of utilities relative to the broader market since 1999, according to data compiled by The Wall Street Journal.                                                

But this year, electric utilities have seen a marked change in their stock market performance as a growing number of investors see these companies as big winners in the AI-driven surge in power demand, high interest rates or not.

The S&P 500 Utilities Sector has been so far the main index's best-performing sector in the second quarter and the third top-performing sector year to date.

Analysts believe that the turnaround in utility stocks' fortunes this year has little to do with concerns about the economy and everything to do with the expected surge in power demand with the AI technologies.

AI-Driven Power Demand Soars

Data centers, especially those powering generative AI and cryptocurrency mining, are not the only energy suckers in recent years. The onshoring of manufacturing of tech components and equipment, including semiconductors, hydrogen electrolyzers, and other factories springing thanks to the Inflation Reduction Act incentives are also straining U.S. grids. Utilities and regulators have raised significantly their forecasts for peak power demand in the coming decade.

NextEra Energy's chief executive John Ketchum told analysts on the company's earnings call last month, "We've been in a period of static demand for decades and the demand is not only coming from data centers. It's coming from decoupling from China, creating more domestic manufacturing around industry, around chip manufacturing, oil and gas industry continues to electrify."

"We continue to even beyond data centers see significant electric demand."

Consulting firm Grid Strategies published a report earlier this year analyzing data from utilities' regulatory findings. The analysis found that over the past year, grid planners nearly doubled the 5-year load growth forecast, the key drivers being investment in new manufacturing, industrial, and data center facilities.

"The U.S. electric grid is not prepared for significant load growth," Grid Strategies said in the report, noting that a recent "surge in data center and industrial development caused sudden, shockingly large increases in 5-year load growth expectations."

U.S. power demand is "likely to experience growth not seen in a generation," according to a report by Goldman Sachs from last month.   

U.S. demand for electricity will rise roughly by 2.4% each year by 2030, and around 0.9 percentage point of that figure will be tied to data centers, Goldman Sachs Research estimates.

This compares with zero growth in U.S. power demand in the decade to 2023.

Goldman Sachs expects data centers will use 8% of U.S. power consumption by 2030, compared with 3% in 2022. Data center power demand is set to jump by 160% by 2030—and to be driven by AI, the investment bank said.

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As a result, utilities could win as they would have more sales, but they will also need to spend more on ensuring demand is met.

"US utilities will need to invest around $50 billion in new generation capacity just to support data centers alone," Goldman said.

There are risks to utilities' revenue growth as the industry is heavily regulated and high capacity spending could lead to higher consumer bills, which could prompt regulators to clamp down on the sector and cap revenues.

"The risk is always that this build-out is very inflationary," Jim Lydotes, deputy chief investment officer of equities at Newton Investment Management, told the Journal.

"It’s going to have to come on the backs of consumer bills.” 

By Tsvetana Paraskova for Oilprice.com

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