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November 20, 2017

MRP Adds Long Electric Utilities as a New Investment Theme; a Renaissance is Underway

Electric utilities are on the cusp of a renaissance powered by four major forces: the electrification of transportation, the proliferation of digital data from IoT and cloud computing, the digitization of money, and advances in energy industry technologies. These shifts are heavily influencing how money is being deployed on infrastructure, which in turn will transform the electric grid from traditional to "smart".

Long considered a boring and static industry, electric utilities have struggled with stagnant demand and an inability to engage customers dynamically as other businesses have. Although more companies and commercial buildings have popped up as the economy has recovered from the Great Recession, total electricity consumption in the U.S. has remained surprisingly stable. Every year since 2007, the amount of electricity sold has hovered just below 4 trillion kilowatt hours. While residential and commercial consumption has edged up during that period, consumption has declined in the industrial and transportation sectors.

Last year, the residential sector accounted for 38% of the nation’s electricity use, and the commercial and industrial sectors consumed 37% and 25%, respectively. Although America’s transportation sector is a major energy consumer, accounting for 29% of the country’s primary energy use, most of that comes from fossil fuels such as gasoline, diesel and jet fuel. The nation’s subways, trains, trolley systems and EVs account for less than 1% of annual electricity consumption. But transportation’s share is expected to jump in the future as consumers move towards less polluting vehicles.

Falling battery costs and tightening regulations around the world has everyone, from the IEA to oil producers to research organizations, revising their electric and hybrid vehicle projections upwards. A new report from the Edison Electric Institute (EII) and the Institute for Electric Innovation (IEI) forecasts that the stock of plug-in electric vehicles (PEV) in the U.S. will rise from 567,000 at the end of 2016 to 7 million by 2025. That’s about 3% of all the cars and light trucks that are expected to be registered that year. The number of PEVs will quickly climb after that.

A U.S. household with an electric car could see a 50% increase in its electricity usage. So, for a standard two-car American household, the electricity bill would double if they switch to EVs. The EII-IEI report also estimates that 5 million charging ports will be needed by 2025. Given these positive projections, electric companies in several states are already engaged in the development of PEV charging infrastructure. Some early movers include Avista in Washington State, Georgia Power in Georgia; KCP&L in Kansas; PG&E, SCE, and SDG&E in California.

The explosion of IOT devices and cloud computing represents another powerful source of electricity demand in the future. The Internet of Things (“IoT”) is about wirelessly connecting everything possible to the Internet - including machines, appliances, objects, and devices – so that these “things” can interact with us (or with each other) remotely, thereby making our lives and businesses function more efficiently. In the process, tons of data is mined and stored in the cloud, to be processed for further use. CISCO predicts the number of connected devices on the Internet will exceed 50 billion by 2020 (from just 8.4 billion this year), then rise to 1 trillion by 2022, and 45 trillion in 20 years.

Meanwhile, more Americans are texting, e-shopping, streaming content, and sharing on social media, just as the country’s government and private enterprises are migrating infrastructure, workloads, and records to cloud platforms and data centers. These trends have propelled the data center boom we’ve seen these past couple of years. A report by the U.S. Natural Resources Defense Council (NRDC) said “Data center electricity consumption is projected to increase to roughly 140 billion kilowatt-hours annually by 2020, the equivalent annual output of 50 power plants, costing American businesses $13 billion annually in electricity bills.”

The projections cited above did not factor in the impact of IoT devices which, separately, will cause U.S. electricity consumption to  climb dramatically. That’s because wireless technologies consume more energy than wired technologies such as fiber, cable or DSL: 3G technologies use 15 times more energy than wired connections, 4G consumes 23 times more energy, and 5G may require even more.

The third leg of the upcoming Utilities Renaissance is founded on the growing acceptance of cryptocurrencies which require a massive amount of power to mine. Ethereum mining and Bitcoin mining, for example, consume about 4.69 terawatt-hours (TWh) and 14.54 TWh (i.e. 14.54 billion kilowatt hours) of power per coin, respectively. Over time, mining will eat up more power, as this trend chart from Digiconomist shows. Bitcoin also requires a fair amount of electricity – 280 KWh - just to process a transaction. Put another way, processing one single Bitcoin transaction requires enough energy to power nine U.S. households in a day.

There are more than 1200 different cryptocurrencies in circulation right now, and no one can say for sure which of these digital currencies will survive. In the U.S., the number and types of businesses accepting Bitcoin is certainly expanding, including even real estate transactions. On the other hand, the U.S. central bank may one day decide to launch its own digital currency, which could drive even established coins like Bitcoin and Ethereum out of the market. However, whether privately-issue or government-issued, cryptocurrencies will still need to be mined, and could become a cash cow for electric power companies.

The growing array of utility-scale energy sources which has come to include wind, hydro, and solar on top of the traditional oil, natural gas, nuclear and coal must seamlessly be integrated into the grid along with new battery solutions. This has spurred new grid modernization activities. From 2011 to 2016, spending on distribution infrastructure grew by 8.6% and spending on transmission infrastructure grew by 16%, which is in sharp contrast to the 1990s when utilities cut way back on infrastructure investments, delaying tens of billions of dollars in upgrades. This new activity is paving the transformation towards the national grid of the future. A “smart” grid or interconnected micro-grids that will be able to dynamically balance supply and demand, and improve the economics of power distribution by detecting and drawing from the cheapest energy resource (be that solar, wind or gas-fired generation).

EVs can play an important role in stabilizing the grid while giving power companies the long-sought opportunity to engage with customers. Most people think of EVs in the context of taking energy from the grid, but an electric car can also operate in a discharge mode, in which it essentially acts as a giant battery and injects the power back into the grid. In this way, EV batteries provide storage capacity for the grid; when demand from other sectors is high, they can feed that power back into the grid to make up for any shortfalls in supply. With dynamic pricing systems in place, EV owners can make a profit by charging their cars when the demand is low (and the energy is cheap) and selling electricity back to the grid when the request for power spikes, thus saving the grid from potential overload.

The accelerating adoption of EVs, cryptocurrencies, cloud computing and IOT devices, combined with the growing pool of distributed energy sources are pushing electric utilities towards an inflection point that will be marked by a significant increase in demand and a more dynamic business model. While the rise in power consumption by EVs will likely be accompanied by a related fall in demand from refineries catering to ICE vehicles, the net changes should still be overwhelmingly positive for U.S. electric companies. These seismic shifts don't appear to be fully priced into the securities yet, which is why MRP is adding the group to our list of active investment themes. As there is no pure-play ETF for electric utilities, we will monitor the theme with the broader Utilities Select Sector SPDR ETF (XLU).

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