Surging AI power demand boosts utility stocks

US investors are piling into utility stocks as the emergence of power-hungry artificial intelligence drives a surge in electricity demand and transforms growth expectations for the once staid sector. 

More than $1.7bn poured into US utilities funds, which have about $41bn across them, in May and June, their best showing in nearly two years, according to data from Morningstar Direct. 

Another $1.1bn is expected to come into utilities funds in July, most of it in the Utilities Select Sector SPDR (XLU) exchange traded fund, according to State Street. 

Utilities often serve as a countercyclical safe-haven investment in turbulent times, so the capital inflows to utility shares during a strong bull market are drawing attention. The stocks provide a relatively cheap way for investors to gain exposure to the AI boom compared to buying more expensive tech stocks such as Nvidia, Microsoft and Google, where much of the gains are already built in.

Jay Jacobs, US head of thematic and active ETFs at BlackRock, said he expected continued investment into utilities funds at least through this year as investors seek out AI opportunities beyond the Big Tech stocks.

“Investors are looking past the Mag 7 names and waiting for the next shoe to drop,” Jacobs said.

Utilities’ emergence comes as Big Tech companies such as Microsoft and Google pump billions of dollars into data centres to power AI, adding to already burgeoning demand from the electrification of vehicles and the reshoring of manufacturing. And AI is putting a far greater call on power generation than the traditional computing that preceded it.

An internet search using an AI service such as ChatGPT requires about 2.9 watt hours of electricity versus 0.3Wh for a standard Google search, according to the International Energy Agency.

AI’s impact on the US energy demand forecast motivated $9.5bn Churchill Management to bulk up its utilities exposure over the past couple of months. The Los Angeles-based investment adviser boosted its exposure to XLU by more than $68mn in the second quarter of 2024, according to data compiled by Bloomberg.

“Utilities has become a go-to sector,” said Churchill president Randy Conner. “You mix a little bit of anything attached to AI, and you get some excitement behind it.”

Shares in the biggest US utilities have surged in recent months, with the S&P 500 Utilities index up 10.4 per cent since the beginning of the year versus -7.1 per cent for 2023 and 1.6 per cent in 2022. The State Street Select Utilities SPDR ETF has risen about 15.3 per cent year to date, per Morningstar.

The rapid expansion of power consumption after decades of stagnation has transformed market interest in utilities, which will need to invest heavily to satisfy it. The increase in appeal also comes amid a more favourable interest rate environment, as federal rate cuts later this year could help debt-dependent utilities burdened with high financing costs.

Prices soared in a power market auction on Tuesday run by PJM, the largest US grid operator, rising more than 800 per cent versus a year ago. PJM, which operates the grid across 13 states in the north-east US, said the market was “sending a price signal that should incent investment”.

Edison International, the parent company of Southern California Edison, one of the biggest US utilities, recently increased capital spending plans from $6bn to $8bn a year. “You’re seeing just a dramatic acceleration of growth” in power demand, said Pedro Pizarro, Edison’s chief executive.

Three utility companies — Vistra Corp, Constellation Energy and NRG Energy — are among the top 10 performers on the S&P 500 this year. Vistra jumped more than 15 per cent on Wednesday after the PJM auction. The company, one of the biggest US generators, is the third-best performer on the S&P 500 this year after Nvidia and Super Micro.

The resurgence of investor faith in utilities funds amounts to a “concerted reversal” after they sustained more than $7.4bn in net outflows over the prior 12 months, said Matt Bartolini, head of SPDR Americas research at State Street Global Advisors.

“You basically have a new business opportunity,” said Bartolini. “Utilities tends to be more of a defensive sector, and right now, it is acting and behaving quite differently, because some of the macro tailwinds have changed, but also because some of the secular client demand has changed.”

Over the past 20 years, US electricity consumption edged up by less than 0.5 per cent annually, according to Goldman Sachs. Between this year and 2030, however, it is expected to grow at 2.4 per cent a year. Utilities have responded by overhauling their spending plans to plough cash into building new generation and transmission. 

The IEA estimates power demand from data centres globally could top 1,000 terawatt hours by 2026 — double 2022 levels and an increase equivalent to the total power demand of Germany. Microsoft said earlier this year it was opening a new data centre every three days. 

“Some of the numbers that utilities are putting out in terms of electricity demand over the next 10 years are numbers the industry hasn’t seen in a generation,” said Travis Miller, energy and utilities strategist for Morningstar.