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Daily Intelligence Briefing

Wednesday, May 8, 2024

Identifying Change-Driven Investment Themes

Please note that we are ADDING LONG UTILITIES to our list of Active Themes, effective today.

See today’s Thematic Investment Idea below for details

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.


I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

US Utilities Finally Find the Right Catalysts for a Capex Hike as Power Price Gains Exceed Inflation

Summary: US electricity prices grew faster than inflation throughout each month of the first quarter. If this trend persists, it could help to bolster utilities’ margins going forward. Underlying the sudden uptick in rates is burgeoning demand growth from data centers and other cutting edge technologies across several different sectors. Industrial and commercial electricity use have been stagnant in the US for most of the past two decades, but that is set to change in the months and years to come. 


Utilities’ expected capex expenditures are being increased quickly as grids across the nation will need to scale up their output levels to keep pace with the intense power demands of generative AI applications, autonomous driving features, and advanced chip fabrication. The US is also the global leader in Bitcoin mining, which may now comprise more than 2% of the country’s total electricity consumption. Rising revenues from improved power pricing and the likelihood of lower interest rates in years to come would ease the burden of construction spending.


Related ETF: Utilities Select Sector SPDR Fund (XLU)

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Though gains in electricity prices had broadly trailed inflation in 2023, Bureau of Labor Statistics data shows growth in power prices have surpassed broad consumer price inflation in each month of 2024. Electricity prices in the Consumer Price Index (CPI) grew by 5.0% YoY in March, the fastest rate recorded since last June. Meanwhile, the annual gain in the total CPI was equivalent to just 3.5%. Increasing electrification and a re-industrialization of the US economy is likely to sustain strong growth in power demand, benefiting US utility providers. In a recent Intelligence Briefing, MRP recently noted that the quickening adoption of generative AI applications has flipped the script for American power providers who had dealt with a decade-and-a-half of slowing growth in electricity consumption until very recently. Other emerging sources of increasingly hungry US power demand, however, will come from the automotive, manufacturing, and digital asset sectors.


Since 2004, industrial use of electricity has not exceeded an estimate of roughly 1.0 trillion kilowatt hours. Similarly, commercial electricity usage has been rangebound between 1.3 and 1.4 trillion kilowatt hours. Per the International Energy Agency (IEA), the US’s 2,700 data centers consumed more than 4% of the country’s total electricity in 2022, but that figure is projected to grow to 6% over the next two years. As data centers increase their share of electricity consumption, they will also expand US electricity use in general. Recent trends however, are expected to disrupt this pattern of relative stagnation. Per Grid Strategies, reports filed in 2023 with the Federal Energy Regulatory Commission show grid planners expect nationwide electricity demand to grow by 4.7% over the next five years. That doesn’t sound like much, but it is an upward shift of more than 80% from 2022 estimates – enough to make Grid Strategies conclude that the electric grid “is not prepared for significant load growth.”


Per Newmark, hyperscalers like Amazon and Microsoft – owners of larger data centers that operate facilities directly under their own management – currently need anywhere from 10-14 kilowatts (kW) to power each rack currently in data centers, but this is likely to rise to 40-60kW for AI-ready racks equipped with the resource-hungry GPUs so critical to generative AI processes. This means that overall consumption of data centers across the US is likely to reach 35 gigawatts (GW) by 2030, up from 17GW in 2022.


Beyond data centers, electric vehicle (EVs) charging stations remain a major infrastructure hurdle in the US, especially as sales of electric vehicles now constitute a significant portion of all US auto sales. EV sales in the US saw an increase of 60% YoY from 1 million in 2022 to 1.6 million in 2023 and, as of February, represented 6.5% of all new vehicle sales throughout the month. PwC estimates suggest the average total annual EV load in the US is set to skyrocket by as much as 1,850% between 2023 and 2040, eventually consuming more than a tenth of all US power. The electricity demands of EVs could also be intensified by increasing consumption from in-vehicle computers, which will likely be equipped with automated-driving features in the not-so-distant future. Per Bloomberg New Energy Finance (BNEF), the electricity consumed by in-vehicle computers could reach 26 terawatt-hours (TWh) in 2040, roughly equal to the demand of 59 million desktop PCs.


Bitcoin mining has long been known as an extremely electricity-intensive operation. The industry that has been built up around BTC’s proof-of-work consensus mechanism is nowhere more common than in the US these days, with the amount of hash rate (the collective amount of computing power being expended on mining) hosted in that US at 38% of the total. Per the EIA, electricity usage from mining operations represented anywhere from 0.6% to 2.3% of total US electricity demand in 2023. MRP has published numerous Intelligence Briefings that explain the dynamics of Bitcoin mining in greater depth. Though the unit price of BTC in US Dollar terms has just recently made a run toward an all-time high above $73,000, the total hash rate has been rising almost constantly since mid-2021, irrespective of the volatile price movements that have occurred in the intermediate. The hash rate just recently touched an all-time high of 721.5 terahashes per second (TH/s). The Bitcoin network has long formed the largest concentrated sum of computing power in the world and it is very likely to keep growing in the US and beyond.


MRP has specifically focused in on the dynamics of Bitcoin mining in Texas, as its power infrastructure has been oft-cited as unreliable during times of peak demand. The reality is that Bitcoin miners have been attracted to Texas due to the fact that electricity is generally very cheap and abundant in the state. Power only becomes scarce and expensive in short-term spurts that represent 5% of all hours, according to the Electric Reliability Council of Texas (ERCOT). For utilities to adequately invest in expanding the grid, they can be incentivized by experiencing greater demand in the opposite 5% of hours where too much electricity is produced and ends up being relatively worthless. Bitcoin miners function as a buyer of last resort for cheap or excess electricity, minimizing losses by utilities who generate too much power, as well as an interruptible load resource when power prices rise too high. Minimizing losses and increasing the grid load during normal operations can incentivize utilities to expand the grid and be better prepared for periods of peak demand. Whereas household electricity use can become ever more essential during a natural disaster or other black swan event, Bitcoin miners would prefer to temporarily wind down operations when it becomes unprofitable.


The key piece of hardware that forms the backbone of all the above-listed technologies is semiconductors. To meet the demands of the future, the US has recently embarked on an ambitious effort to revitalize domestic chip production with billions of Dollars of subsidies in hand. A Stand.Earth report notes that nine new semiconductor factories being built in the US by four of the biggest manufacturers — Intel, TSMC, Samsung, and Micron – could cumulatively add 2.1 gigawatts (GW) in new electricity demand to state grids over time. Expansions of existing semiconductor factories will also play a role in boosting power demand. One GlobalFoundries fabrication plant in New York is expected to spend billions to expand its output capacity, piling more than 0.7 GW onto its current electricity needs by 2035.


Per Statista data, shareholder-owned US utilities’ annual capex budgets had not grown by a double-digit percentage once between 2012 and 2021, but in 2022 jumped out to 10.4%. This is expected to be exceeded by projected 2023 growth of 11.3%. Capex budgets are rising in tandem with a sudden uptick in demand expectations, which will likely bolster revenue significantly.


In February, owner of the fifth-largest utility provider on the east coast, Duke Energy, raised its five-year capital expenditure plan by $8 billion (12.3%) above previous guidance to $73 billion. Duke reported that its load growth projections had doubled to about 2% in the last year, citing rebounding industrial activity as one of the key factors driving up electricity demand. As The Wall Street Journal reports, Southern Company, a utility company serving customers in Georgia, Mississippi, and Alabama, now expects 6,600 megawatts (MW) of demand growth through the winter of 2030, 17 times greater than its previous forecast. Like Duke, Southern recently boosted its own five-year capex schedule by $5 billion (11.6%) to $48 billion to cover the 2024-2028 period. An expected decline in interest rates throughout the next few years monetary policymakers should be favorable for utilities shares, easing the burden of expenses associated with debt-intensive capital investments.


An updating to America’s power infrastructure has been sorely needed, even prior to the recent emergence of generative AI applications. MRP has noted for years that stagnant growth in electricity demand and prices has led to underinvestment in the power grid. If that kind of apathy went unchecked for much longer, it could lead to an infrastructure crisis in years to come. A 2021 report by the American Society of Civil Engineers (ASCE) found that 70% of transmission and distribution lines are well into the second half of their expected 50-year lifespans and will need to be replaced throughout the next couple of decades. The ASCE had anticipated that by 2029, the US would face a gap of about $200 billion in funding to strengthen the grid. It is possible that the advent of AI and other advanced technologies have begun to narrow that gap.


Utilities have finally encountered several catalysts that will materially shift the trajectory of electricity demand in the US. The need to accommodate much greater demand than what is available currently will push up prices for electricity and incentivize utilities to invest more strongly in the grid. As such, MRP will be adding LONG Utilities to our list of Active Themes, effective today. We will use the Utilities Select Sector SPDR Fund (XLU) to track the performance of this theme.


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