(Bloomberg) — Investors looking for a unique route into the stock market’s artificial intelligence boom are finding an interesting banking opportunity in what has traditionally been the dullest corner of the stock universe: utilities.
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AI is the buzzword these days, and everyone from chipmakers to computer equipment makers to automobile manufacturers are trying to present themselves in these hopeful colors. It’s also driving the recent stock market rally, as investors have seen over the past week.
On Thursday, shares of Meta Platforms Inc. posted their worst performance since October 2022 after the company said it would spend far more than expected on AI development. Then on Friday, the market value of Google parent Alphabet Inc. rose to more than $2 trillion, while shares of Microsoft Corp. also rose after companies showed progress in AI in their quarterly results.
But here’s the thing about AI technology: it requires a tremendous amount of energy to develop and execute. And this is where utilities come into play.
“The power needs of data centers were already huge, then the AI hype came along and the need for power skyrocketed,” said Manju Naglapur, senior vice president and general manager of cloud, application and infrastructure solutions at Unisys Corp. “With all this money.” Investing in data centers will massively increase electricity consumption.”
The utilities sector of the S&P 500 Index fell 10% in 2023, its worst year since 2008, making it the weakest group in the stock benchmark, which rose 24% overall. That wasn’t exactly a surprise, considering that companies tend to perform poorly in times of persistently high interest rates.
Shares have recovered somewhat in 2024, rising 4.4% as cost controls offset higher refinancing costs and record investment. But the biggest shift in sentiment among utilities is hope for increased demand from the new power-guzzling data centers needed to expand AI.
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“The AI narrative is driving the most investor interest,” said Ryan Levine, head of utility reporting at Citigroup Inc. “It has the potential to be the industry’s biggest driver.”
Across the U.S., utilities are preparing for a historic surge in electricity demand driven by data centers and AI. Even outside Data Center Alley in Northern Virginia, where Dominion Energy Inc. temporarily stopped connecting new data centers in 2022 due to grid constraints, companies are planning new power plants and transmission lines.
Artificial intelligence is poised to help increase the power demand of Chicago-area data centers by 900%, potentially requiring as much power as about four nuclear power plants can produce, Exelon Corp. Chief Executive Officer Calvin Butler said recently. Southern Co. expects electricity sales to grow 6% annually, with about 80% coming from data centers.
Read more: AI needs so much electricity that old coal-fired power plants are shut down
This explains why Goldman Sachs Group Inc. has launched two investment baskets – Power Up America and Data Center Equipment – for clients looking for alternative ways to deal with the coming AI explosion. While the bank doesn’t disclose the stocks in its baskets, it selects companies based on four categories: unregulated and regulated utilities, smart grid infrastructure and power-generating raw materials.
“We believe these themes, along with Goldman’s Broad AI basket, will be the most popular over the next few years,” Faris Mourad, the company’s vice president of U.S. custom baskets, said in a telephone interview.
So far this year, the power-up basket is up nearly 28%, and the data center equipment basket is up more than 18%. Those are some big numbers considering the normally successful technology sector in the S&P 500 is up just 8.3% in 2024, and communications services, which includes social media companies, led the group with a 17% increase the best performance in the index.
Meanwhile, Mourad expects the Power Up America basket’s year-end 2024 earnings to be 21% higher than originally forecast in January 2023. And he sees more gains ahead.
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Energy availability is an important consideration when data center operators decide where to build. Typically, they go to a local utility to discuss how much electricity they need, and then the utility applies for approval to build a new facility or purchase electricity from a third party. For example, Georgia Power, the largest subsidiary of utility holding company Southern, recently received approval from the Georgia Public Service Commission to expand its capacity by 1.4 gigawatts to meet demand from data centers and other businesses.
“On this basis, we recommend buying Southern Co.,” Citigroup’s Levine said.
Access to renewable energy sources is also an advantage. Aaron Dunn, co-head of value equity and portfolio manager at Morgan Stanley Investment Management, likes NextEra Energy Inc. because the company builds renewable energy for its own utility and develops renewable energy for others.
“We believe renewable energy and storage play a key role in meeting this increased demand,” NextEra CEO John Ketchum said during the company’s first-quarter earnings call on Tuesday. “The U.S. renewable energy and storage market opportunity has the potential to grow three times larger in the next seven years compared to the last seven years.”
As data center developers look for low-cost locations, Dunn expects the Midwest to become an economic powerhouse because land is cheaper than in other parts of the country. “This also applies to a company like CMS Energy Corp. to the credit that operates out of Michigan,” he said.
In fact, CMS said in its conference call Thursday that it has signed a contract for a new 230-megawatt data center and that other companies are planning to build it in Michigan.
Of course, all of this demand can only benefit utilities if they can produce the electricity to meet that demand. Many energy experts fear that the U.S. power grid is unprepared for the coming wave. And that’s leading some investors to turn to the companies tapped to bolster the power grid so utilities can adapt to the new high-energy environment.
“This is going to be a real challenge for traditional utilities,” said Walter Todd, chief investment officer at Greenwood Capital Associates, which owns stocks including Eaton Corp. and Hubbell Inc. “The real beneficiaries of this data center power consumption are those who will benefit from the money spent on modernizing the network.”
– With assistance from Josh Saul, Mark Chediak and Geoffrey Morgan.
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