We Want to Own a Basket of Utilities

In 2020, we met with a tiny Canadian tech company that had a compelling story.

 They used a combination of artificial intelligence (A.I.) and smart monitors to save companies money on their electric bills. A lot of money.

When we saw them, they had two major clients – Starbucks and Bank of America. The company used smart thermostats to control the temperature of the offices. The savings were shocking.

Sadly, the company died of managerial stupidity. But the idea was sound. Letting an A.I. manage utilities to save money is a great idea. And other companies caught on.

Alaska Airlines used A.I. to optimize about 25% of its flights in 2023. By shaving off a few minutes here and there, it cut over 680 hours of flight time. That saved more than half a million gallons of fuel. At an average price of $6.50 per gallon, that’s a few million dollars’ worth of savings…on just 25% of its flights.

This story will become more popular over time. The adoption of A.I. into the workplace will grow exponentially over the next couple of years. Especially once companies see how much money they can save.

This month, we’re revisiting the A.I./Energy nexus. We see it as a major investment opportunity for the next few years. And if we get in now, we can profit as the trend grows.

A.I. and Energy – A Mixed Blessing

The landscape of energy is going through a huge transformation.

Historically, electricity came from a huge central power plant. Today, with the proliferation of wind farms and solar farms, there are many more power plants. That complicates the balance of energy because the supply must be balanced with demand.

And here’s the kicker, as we discussed last week. According to analysts at Morningstar, Global power consumption from data centers was roughly 460 TWh in 2022 and could double by 2026 to more than 1,000 TWh. That’s equal to the power demands of Japan.

That’s an astonishing growth rate of 16.8% per year.

And here’s what’s incredible. According to S&P Global Market Intelligence, Northern Virginia was number one for the 2023 total power capacity of the top ten largest data center markets globally. Beijing was the second largest market with a little below 2,000 MW of capacity.

That means U.S. electrical utilities will see a massive growth in power demand.

The report also said that power demand from data centers will grow to about 30,694 MW once all the planned data centers are operational. Investor-owned utilities are set to supply 20,619 MW of that capacity.

That’s why we want to own utilities today. They should grow dramatically with the rising demand.

The International Energy Agency (IEA) published a report on Why AI and Energy are the New Power Couple:

Power systems are becoming vastly more complex as demand for electricity grows and decarbonisation efforts ramp up. In the past, grids directed energy from centralised power stations. Now, power systems increasingly need to support multi-directional flows of electricity between distributed generators, the grid and users. The rising number of grid-connected devices, from electric vehicle (EV) charging stations to residential solar installations, makes flows less predictable. Meanwhile, links are deepening between the power system and the transportation, industry, building and industrial sectors. The result is a vastly greater need for information exchange – and more powerful tools to plan and operate power systems as they keep evolving.

We highly recommend reading this article. It lays out how powerful A.I. will be, in conjunction with the changes to the power supply.

That’s where A.I. is going to transform the landscape of energy. It will start with efficiency and grow.

We Want to Own a Basket of Utilities

Believe it or not, utilities do quite well in inflationary environments. Better than bonds and often better than stocks. Certainly, in 2024, utilities soared as you can see in the chart below. That’s a trend we want to ride.

This month, we are going to recommend a fund whose holdings are almost unrepresented in the S&P 500. The SPDR XLU ETF holdings make up less than 2.5% of the S&P 500.

Has $13.2 billion and pays a 3.0% dividend yield.

The benefit of buying this basket is that we eliminate individual company risk. We want to ride the trend that comes from higher electric power demand from A.I. Buying the ETF gives us that, without the risks that come with individual companies.

If you bought NextEra, don’t worry. You should still do well. But this ETF holds a basket of the major utilities in the U.S. It offers us a different value proposition than the single utility play.

Here are the top ten holdings of the fund:

• NextEra Energy – 14.2%
• Southern Co. – 8.0%
• Duke Energy – 7.3%
• Constellation Energy – 6.3%
• Sempra Energy – 4.5%
• American Electric Power – 4.5%
• Dominion Energy – 4.1%
• PG&E – 3.5%
• Exelon – 3.5%
• Public Service Enterprise Group – 3.4%

These are the major utilities in the U.S. XLF gives us exposure to the entire group.

Action to Take: Buy the Utilities Select SPDR Fund (NYSE: XLU) and use a 25% trailing stop.

That means, if you paid $71.50 per share for XLU, you would sell if it closed below $53.63 per share. While we see this as a long-term trend, it has done well over the last few months. We want to limit our exposure just in case something macro-economic happens.

I know some of you sold NextEra and didn’t get back in. XLU offers us a terrific way to diversify our utilities and make a bit of money from the dividend as the sector grows. We see this as a three-to-five-year trend in the making.

For the Good,

The Mangrove Investor Team