The sleepiest sector in the market is becoming the main winner of the artificial intelligence boom

The rapid development of artificial intelligence technology has created the most unlikely winner in the stock market.

Energy companies that will meet growing demand for data center power and generative AI have gone from the market’s sleepiest fixed-stock investment to the hottest bet on the AI ​​boom.

After the market’s worst performance in more than two decades in 2023, the utilities sector is clearly on Wall Street this year, marking a dramatic shift in sentiment and rising stock prices as investors bet on the companies that will power the future of artificial intelligence.

The tools shine

Utilities typically play a defensive stock game because they offer consistent and stable profits even in times of recession because revenues from providing customers with electricity and water are stable and safe even in times of economic downturn – everyone needs the services these companies provide.

The flip side of utility stocks is that they don’t grow when the economy is booming. They also suffer in a high-interest rate environment like the current one because investors seek higher-yield alternatives, such as Treasury yields, as interest rates rise.

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

Related: Why oil may regain growth momentum

Last year, as interest rates rose, the Dow Jones Utility Index fell 7.2%, while the S&P 500 Index rose 26.3%. It was the worst performance for the utilities sector compared to the broader market since 1999, according to data compiled by The Wall Street Journal.

This year, however, utilities have seen a marked shift in their stock market performance as a growing number of investors see these companies as the big winners from AI-driven energy demand growth, high interest rates or not.

The S&P 500 utilities sector was the major index’s best-performing sector so far in the second quarter and its third-best performing sector since then.

Analysts believe that this year’s change in the fortunes of utility companies has little to do with concerns about the economy and everything to do with the expected increase in energy demand thanks to AI technologies.

The demand for power controlled by artificial intelligence is growing

Data centers, especially those powering generative artificial intelligence and cryptocurrency mining, haven’t been the only energy suckers in recent years. The relocation of production of technology components and equipment, including semiconductors, hydrogen electrolysers and other factories created with incentives under the Inflation Control Act, is also straining U.S. energy grids. Utilities and regulators have significantly raised their forecasts for peak power demand in the coming decade.

NextEra Energy CEO John Ketchum told analysts on the company’s earnings call last month: “We’ve been in a period of static demand for decades, and it’s not just coming from data centers. It comes from separating from China, creating more domestic manufacturing around the industry, around chip manufacturing, the oil and gas industry continues to electrify.”

“We continue to see significant demand for electricity, even outside of data centers.”

Consulting firm Grid Strategies released a report earlier this year analyzing data from utility regulators’ findings. The analysis found that network planners have almost doubled their five-year load growth forecast over the past year, with investment in new manufacturing, industrial and data center facilities being the main drivers.

“The U.S. power grid is not prepared for significant load growth,” the Grid Strategies report said, noting that recent “explosive growth in data centers and industrial development has resulted in a sudden, shocking increase in expectations for load growth over the next 5 years.”

A report last month by Goldman Sachs said energy demand in the U.S. is “likely to experience growth not seen in a generation.”

According to Goldman Sachs Research estimates, electricity demand in the US will grow by approximately 2.4% annually by 2030, of which approximately 0.9 percentage points will be related to data centers.

This compares with zero growth energy demand in the US in the decade to 2023

Goldman Sachs expects data centers to consume 8% of U.S. energy consumption by 2030, up from 3% in 2022. Data center power demand is expected to grow 160% by 2030 and will be driven by artificial intelligence, says the investment bank.

As a result, utilities could benefit because they would make more sales, but at the same time they would have to spend more to ensure demand is met.

“U.S. utilities will need to invest approximately $50 billion in new generation capacity just to operate data centers,” Goldman said.

There are risks to utility revenue growth because the industry is highly regulated and high capacity spending can lead to higher consumer bills, which could prompt regulators to clamp down on the sector and limit revenues.

“There is always a risk that this expansion will be very inflationary,” Jim Lydotes, deputy director of equities at Newton Investment Management, told the Journal.

“It will have to be tied to consumer bills.”

Author: Tsvetana Paraskova for Oilprice.com

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