August 7th, 2015
by Chris Mayer, Daily Reckoning
"Power utilities now face uncertainty of a kind that traditional phone companies faced when cellular technology emerged," writes Bill McKibben in The New Yorker.
It's an apt analogy. The disruptor in this case comes from solar and other technologies, which reduce the demand for electricity.
Consider this striking observation from Horizon Kinetics, a money management firm based in New York: The U.S. economy has grown in the last six years. Yet electricity demand fell over the stretch -
"a heretofore unknown occurrence in the history of the U.S. electricity demand."
Whenever you stumble on something that has not happened before, you should stop and take a deeper look.
Some of this fall in demand is because the products we use are more energy efficient. A fridge in 1978 used about 1,800 kwh per year. Today's versions use less than 400 kwh. And you can replace an existing 60W bulb with a 13W compact fluorescent or an 8W LED. These are just a few energy-saving changes anyone can make.
And millions of people have made these changes. They continue to make them. McKibben's article kicks off with a story about a family in Vermont. They put a solar array on their roof and switched all of their light bulbs to LED. They also installed new heat pumps.
Before the makeover, the household consumed 3,411 kwh and 325 gallons of fuel oil. After the makeover, it dropped to 2,856 kwh and no oil at all. As McKibben points out, the household reduced their carbon footprint by 88% and at no net cost.
And this is with off-the-shelf technology. You can get this stuff at your nearby Lowe's or Home Depot.
Solar's story is also one that's really astounding. According to McKibben, the price of solar fell 95% in the past four decades and 75% in the last six years. It now produces power as cheaply as coal and gas.
"And because it's a technology, rather than a fuel, the price should continue to fall. As it has for cellphones."
In markets where there is no grid, solar is the first option. Just as happened with cellphones, the frontiers leapfrog the older technology. McKibben uses the example of Bangladesh, a poor country, where people install more than 60,000 solar arrays a month.
The growth rate- and potential - in solar is hard to fathom. SolarCity, which is the largest installer of rooftop solar arrays, finishes one about every three minutes. The CEO and co-founder of Solar City said:
"That sounds impressive, but it's only 200,000 homes so far, out of 40 million [in SolarCity's market area]."
His goal is to get that rate to one every three seconds.
Some states are further along than others. Hawaiians pay the nation's highest electricity costs. But that's changing. The Wall Street Journal recently covered the efforts of the state to switch to renewable power such as wind and solar. Already 21% of Hawaiians' power comes from renewable sources, and the islands have a law mandating 100% by 2045.
The Journal reports:
"Hawaii remains the only state that still burns oil to generate most of its electricity. Partly as a result, an unusual number of islanders have put solar panels on their roofs. On Oahu, where most of Hawaii's population lives, 13% of residential utility customers have solar systems, more than any other state."
Add up the above and you see why nearly a third of all new electricity generation today is solar. Solar's market share is small but gaining rapidly, with a 60% growth rate since 2008. At that rate, solar capacity grows 10-fold every five years - or 100-fold every 10.
Long term, these stories spell the death of both coal and natural gas as a source of electricity (and oil too). It will take time, but if you bet on coal or natural gas, you are on the wrong side of history. Those bets are like those made on newspapers and video rental stores on the eve of the Internet age.
I think the same idea applies to utilities. It's going to be a tough road ahead for them. But you would never know it looking at the stock market. Utilities have valuations well above historical norms. Price-earnings ratios are at records for the group, and the gap between dividend yields and Treasuries have narrowed.
Here we get back to Horizon Kinetics. Their December report titled Electric Utilities: Perhaps not the Investment One Expects, says this:
At these valuation levels, it appears that a range of disruptive changes in the industry fundamentals are not being priced in, and that investors who simply buy these securities seeking income during the current long yield crisis, expecting dividend increases and generally a "safe" investment, could be vulnerable to a severe valuation contraction.
The report presents an interesting analog in European utilities. Europe is a few years ahead in the solar game. In 2008, the top 20 utilities were worth about $1.3 trillion. Today, they are worth half that. In fact, they have been the worst-performing stocks in Morgan Stanley's index of global share prices.
There you can see the effect of competition from wind and solar - and net metering, which allows consumers to sell power back to the utilities.
As I mentioned, Horizon Kinetics' report came out in December. It's been a good call so far. The stocks are down on the year. For example, the Utilities Select Sector SPDR Fund (XLU), a popular utility exchange-traded fund, is down 10% on the year. But if the thesis outlined here proves right - and I think it will - then we've got a long way down still ahead.
At current prices, it would not take much for a 50% decline. Say we value utilities at 11 times trailing earnings and at a dividend yield of 6%. That's in line with history, according to Horizon. And that's before the future turned as bleak as it now. In such a case,
"the shares could decline by 50% without necessarily appearing to be inexpensively valued."
Utilities are a sell.