AI Boom Spurs Surge in Utility Stocks as Power Demand Soars

Key Insights:

• Utility stocks attract investors due to rising AI power demand, offering a cheaper alternative to high-priced tech stocks.
• Major utilities see growth as AI boosts electricity needs, transforming them into a thriving investment sector.
• Utilities funds rebound with significant inflows, driven by AI-driven power consumption and favorable interest rate forecasts.

US investors increasingly turn to utility stocks as the demand for power-hungry artificial intelligence (AI) technology surges, transforming growth expectations in the utilities sector. In May and June, US utilities funds received over $1.7 billion, marking their best performance in nearly two years, according to Morningstar Direct. 

Based on data from State Street, an additional $1.1 billion is expected to flow into these funds in July, predominantly into the Utilities Select Sector SPDR (XLU) exchange-traded fund.

Traditionally considered a safe-haven investment during economic turbulence, utilities are now attracting attention during a strong bull market. They offer a relatively inexpensive way for investors to benefit from the AI boom compared to the more expensive tech stocks like Nvidia, Microsoft, and Google, whose gains are already substantial. 

Jay Jacobs, US head of thematic and active ETFs at BlackRock, anticipates continued investment in utilities funds throughout the year as investors seek AI opportunities beyond the major tech companies.

Increasing Power Demand from AI and Tech Giants

The AI-driven demand for electricity is significant, with companies such as Microsoft and Google investing billions in data centers to support AI infrastructure. The International Energy Agency reports that an AI-powered internet search, such as one using ChatGPT, consumes approximately 2.9 watt-hours of electricity, compared to 0.3 watt-hours for a standard Google search.

This rising power consumption has prompted firms like Churchill Management to increase their utilities exposure, investing over $68 million in XLU in the second quarter of 2024. “Utilities have become a go-to sector,” said Churchill president Randy Conner. He noted that the excitement around anything AI-related has spurred interest in utility stocks.

Utilities Funds Show Strong Performance

Shares of major US utilities have seen notable gains, with the S&P 500 Utilities index up 10.4% since the beginning of the year. According to Morningstar, the State Street Select Utilities SPDR ETF has risen about 15.3% year-to-date. This growth marks a reversal from the previous year, where utilities funds experienced over $7.4 billion in net outflows.

The surge in power consumption, driven by AI and other technologies, has transformed utilities into a growth sector. This shift is also supported by a more favorable interest rate environment, as anticipated federal rate cuts could benefit debt-dependent utilities struggling with high financing costs. 

PJM, the largest US grid operator, recently saw prices in a power market auction rise more than 800% compared to the previous year. PJM stated that this price signal should encourage investment in the sector.

Expansion Plans and Future Outlook

Edison International, parent company of Southern California Edison, has increased its capital spending plans from $6 billion to $8 billion annually to meet the rising power demand. “You’re seeing just a dramatic acceleration of growth in power demand,” said Pedro Pizarro, Edison’s chief executive.

Vistra Corp, Constellation Energy, and NRG Energy are among the top performers on the S&P 500 this year, with Vistra seeing a more than 15% increase following the PJM auction. The company is currently the third-best performer on the S&P 500 after Nvidia and Super Micro.

The revival of investor interest in utilities signifies a major shift, as noted by Matt Bartolini, head of SPDR Americas research at State Street Global Advisors. He stated that utilities, traditionally seen as a defensive sector, are now benefiting from changing macroeconomic conditions and increasing demand from AI and other technologies.

Over the past two decades, US electricity consumption grew by less than 0.5% annually. However, Goldman Sachs projects that between this year and 2030, it will increase by 2.4% annually. Utilities are responding by significantly boosting their investment in new generation and transmission infrastructure. 

The International Energy Agency predicts that power demand from data centers globally could exceed 1,000 terawatt-hours by 2026, doubling 2022 levels and equating to the total power demand of Germany.

Microsoft is among the companies rapidly expanding its infrastructure, opening a new data center 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.

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