The Energy Transition Makes Power & Utilities Pro-Cyclical?
Look up any historical investments book and pretty early on there is are definitions of cyclical, defensive, and counter-cyclical businesses.
A cyclical business is inherently discretionary and peak and bust at an economic cadence. Within my focus, this is oil & gas, airplanes, jewelry, construction, etc. A defensive business is easier to define: a staple where demand is consistent and swings more muted. By its’ regulated design, the power and gas utility business are inherently defensive.
What I find fascinating is how technology and the energy transition is going to move the overall power and utility markets from defensive stock characteristics to more cyclical in nature.
How? There are two reasons, I detail below:
1- Time To Value -> Mismatched Supply -> Cyclicality
Generally, the longer it takes for a good to go from raw materials to value delivered causes imbalances in the supply chain. Historically this delay in oil and gas has resulted in mismatched supply to the market due to decisions made under a different economic assumptions. (Other industries include airlines: the time from order to delivery may look quite different!)
What Changes? As the electrify everything mantra grows, I have been vocal how “the firm that controls demand will win the market.” And as power prices continue to plummet amidst an overbuild scenario, the firms that have demand are the ones that will set the terms. And those terms won’t be fixed rate, like they are today. The energy consumer will tie the power price to their underlying product demand and margin profile.
This moves the standard power contract from a more proximate and certain customer relationship to distanced and uncertain value payout. Power investments will have less certainty and mismatched capital allocations will occur as these power companies gain more exposure to their customer’s cyclical demand.
2- Technology Transition results in Power Quality Pricing
Most energy transition professionals assume some future rosy grid that is self-balancing amongst renewables, EV charging, consumer adjustments, etc. Maybe 50 years from now. But the intermediate steps are going to be messy. And
What Changes? I believe this “intermediate messiness” will result in greater awareness around power quality (Californians get this with the blackouts) and the ability for quality-based pricing around uptime, power quality (data centers, etc.) and source. This transition happens in most verticals: a commodity product ultimately leads to a premium version. That hasn’t happened in electricity yet but I suspect the new energy economy (wind, solar, batteries) and consumer willingness to pay for quality will happen here as well.
And when a product has multiple price points, the premium offerings are naturally more susceptible to economic swings and cycles.