Extending the life of current energy infrastructure will bridge to new supply: Citi's Ryan Levine

Key Concepts

• Electricity Bill Inflation
• Data Center Demand
• Hyperscalers
• Regulatory Mechanisms (Utilities)
• Negotiated Contracts
• Carve-outs
• Regional Power Grid Capacity
• Baseload Power
• Small Modular Nuclear (SMR)
• Intermittent Power
• Behind the Meter Generation
• Wires Company

Overview of Electricity Cost Increases

The average electricity bill is projected to increase by approximately 4% this month and remain elevated through next spring, according to a report from the US Energy Information Administration. Over the last five years, electricity prices have risen by about 23%. This increase is attributed to a confluence of factors, not solely the surge in data center demand.

Key Drivers of Electricity Price Hikes:

• Overall Inflation: General economic inflation contributes to rising operational costs for utilities.
• Storm Costs: Significant weather events have led to increased costs in specific regions, such as California, Louisiana, and North Carolina, for infrastructure repair and resilience.
• Renewable Policies: Certain renewable energy policies have impacted select states, influencing electricity bill drivers.
• Data Centers: While a significant factor, their impact is more regionally focused, particularly affecting some utilities in the Northeast and Mid-Atlantic due to unique regulatory mechanisms.

Impact of Data Centers and Utility Responses

The substantial increase in electricity demand from large data centers, often referred to as "hyperscalers," presents a challenge for local utilities. While this demand drives up prices, utilities cannot disproportionately charge these large customers compared to others.

Utility Strategies to Manage Hyperscaler Demand:

• Heavily Negotiated Contracts: Over the past two years, utilities have engaged in intensive negotiations with hyperscalers, often resulting in long-term agreements, such as 12-year contracts.
• Residential Customer Protection: A primary goal of these contracts and arrangements is to shield residential customers from the full impact of increased demand and associated costs.
• Carve-outs: In some instances, utilities have created "carve-outs" where the portion of the bill or utility service provided to a hyperscaler does not affect other customers.
• Structures Outside Regulated Utility Model: Negotiated transactions have led to the creation of financial and operational structures that operate outside the traditional regulated utility model, specifically designed to protect residential customers.

The regional power grid's capacity has been particularly affected, leading to an increased price for power capacity, which in turn has created short-term inflation in electricity bills in certain parts of the country.

Strategies for Increasing Electricity Supply

To address the escalating demand, particularly from data centers, increasing electricity supply is a critical solution. Supply is estimated to grow over 2.8% annually through 2040, with this projection potentially rising further as capital expenditure (CAPEX) and data center demand continue to increase.

Methods for Fueling Future Electricity Supply:

• Short-Term Solutions (Bridge Resources): These focus on extending the life and capacity of existing infrastructure.
  • Restarting Old Nuclear Assets: Three projects are currently underway to bring retired nuclear plants back online.
  • Gas Generation: Additions around natural gas and even less efficient forms of gas generation are being utilized.
  • Extending Coal Plant Lifespans: Keeping coal assets running longer, as exemplified by the recent decision regarding the Campbell Plant in Michigan, serves as a bridge until new power plants can be constructed. This strategy aims to maintain "baseload, around-the-clock power."
• Long-Term Solutions (New Power Plants):
  • Renewables: Continued development of renewable energy sources.
  • Natural Gas: More significant investment in new natural gas power plants.
  • Newer Technologies: Potential future reliance on advanced technologies such as Small Modular Nuclear (SMR), large-scale nuclear, and other developing power generation methods designed to meet the needs of increasingly power-hungry customers.

Role of Alternative Energies in Supply Outlook

Regarding the administration's support for alternative energies, Ryan Levine believes that any withdrawal of support has not had a meaningful impact on the longer-term supply picture.

Reasons for Limited Impact:

• Supply Chain Constraints: Renewable energy projects often face supply chain limitations that hinder their deployment.
• Intermittency: Renewables are inherently intermittent and not available 24/7, which is a critical requirement for hyperscalers and for maintaining a stable power supply for the general public. Therefore, they are not the preferred resource for ensuring constant power.
• Policy Slowdown: While there has been a slowdown in wind and other renewable resources due to policy shifts, this is not seen as a deterrent to keeping the lights on for data centers or the broader economy.

Recommended Utility Investments

Ryan Levine highlights specific utilities that are well-positioned to benefit from the current environment of increasing data center demand.

Recommended Utilities:

• DTE Electric (Midwest):
  • Growth Story: Expected to see continued emergence of data center growth in the coming months.
  • Specifics: Anticipates 2 to 4 large hyperscalers in the Michigan area.
  • Innovation: Planning to build "behind the meter generation" (on-site power generation) with the expectation of securing an air permit for this initiative.
• First Energy (Mid-Atlantic, Ohio, Pennsylvania):
  • Company Type: Primarily a "wires company," focusing on electricity transmission and distribution.
  • Growth Potential: Expected to experience meaningful earnings growth as the need for data centers increases in its service area.
  • Valuation: The stock is considered less expensive, offering significant upside potential for investors.

Conclusion and Main Takeaways

The electricity sector is undergoing significant transformation driven by overall inflation, storm costs, renewable policies, and critically, the surging demand from data centers. While data centers are a regional driver of price increases, utilities are actively implementing sophisticated strategies, including heavily negotiated contracts and carve-outs, to protect residential customers. The long-term solution involves a multi-faceted approach to increasing supply, combining short-term measures like extending the life of existing nuclear and fossil fuel plants with long-term investments in new natural gas, renewables, and advanced nuclear technologies like SMRs. Despite shifts in alternative energy policy, their intermittent nature limits their immediate impact on the 24/7 power needs of hyperscalers. Investors are advised to consider utilities like DTE Electric and First Energy, which are strategically positioned to capitalize on this evolving demand landscape.