It appears global investors are waking up and suddenly realising – who is going to power the artificial intelligence (AI) demand boom? We know the software and chipmaker companies who will benefit from the AI boom, as reflected in their share prices. However, attention has, rightly, also turned to how we are going to provide the electricity to power this structural growth story given how energy intensive AI is. The utilities sector is now catching investors’ attention and we believe it will be an important theme over the medium term.
Utilities find a new life
The usually uneventful & boring utilities sector is catching some attention of late as a consequence of abovementioned questions. So much so that even rising long-term bond yields in the U.S. has not disrupted the recent rally in utilities companies. Historically there is a negative correlation between the two – that is, when bond yields rise, the share price of utilities fall. At the time of writing, the U.S. Utilities Select Sector SPDR ETF was up +21.3% from its lows in Feb-24, despite the U.S. 10-year Treasury yield also rising over the same period. The Australian utilities companies have also caught the bug, with the share price of ASX-listed merchant retailers AGL Energy (AGL) and Origin Energy (ORG) up +22.6% and 21.8%, respectively, over the same period.
The AI boom thematic is broadening
Firstly, it is worth pointing out that the recent performance of utilities is not just about the AI theme broadening to the utilities sector. It also has to do with the recent quarterly earnings update provided by the utilities companies listed on the S&P 500 Index – it was a standout performance with respect to earnings. However, the AI beneficiary boom has also made its way to utilities, and this is where the future earnings growth potential for merchant utilities could see a material change. At the end of the day, all the data centres, EVs, and green transition will significantly increase power demand and in fact could materially accelerate it. Let’s just take the power required for data centres. AI is driving growth in global demand for data centre capacity. According to a recent presentation by NEXTDC (NXT) – an Australian data centre operator – historically the global data centre market has grown at a +15% CAGR (compound annual growth rate) between FY17 to FY23, supported by digitisation and cloud migration megatrends. However, with the emergence of AI megatrend and the pace of adoption, the market growth rate is expected to accelerate to a +19% CAGR over 2024-2027.
Figure 1: Global data centre market (MW) Source: NEXTDC
The aging power grids are not ready
In a recent earnings call with the CEO of U.S. listed Generac Holdings Inc (GNRC) – a manufacturer of automatic, stationary standby, and portable generators – the CEO noted: “the amount of power that will be drawn from those data centres will triple from the current levels that we’re at today. It’s almost the equivalent to adding 40 million households to the grid…the aging power grid in the U.S. is clearly not prepared for the future trajectory of power consumption needed to satisfy these converging trends…”
Data centre customers paying a premium to secure supply
Recently we have seen global companies like Amazon move to secure energy supply. Amazon recently agreed to purchase a data centre campus attached to the U.S.’ sixth largest nuclear power facility and will reportedly take up 40% of the output of the nuclear facility. Interestingly, this then reduces the amount of power which would otherwise be going into the grid for other consumers. Which means that power will need to be sourced from other energy sources – that is, solar panels, wind turbines etc. If other sources are not readily available to fill the gap, it will likely put upward pressure on prices for other consumers.
A lot more investment is required
We see the potential for a capital expenditure boom in the utilities sector. According to global investment bank Goldman Sachs, capital expenditure requirements for companies they cover needs to increase by approximately 36%. This has material implications for cash flows and valuations, as investors need to evaluate which companies will actually get an attractive return on this investment.
Figure 2: Goldman Sachs capex forecast for stocks under their coverage. Source: Goldman Sachs
Find out more about BanyanTree Investment Group, their research, and portfolios by clicking here.
Investment Manager / Director at BanyanTree Investment Group
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