Will heat waves burn energy resources?

Utility companies are warning customers to cut back on electricity use as temperatures across the world hit record highs. Although these companies are regulated and therefore have an incentive to invest in their resources, the increase in supply throughout the year would lead to higher prices for clients, says the Chief Investment Office (CIO) of UBS. They maintain their neutral view on US utilities, but stress that investments in utility infrastructure will help support stable earnings growth for US utilities.

Heat waves are raging across Europe and the central and southwestern United States. The UK hit its highest recorded temperature of 40.2C (104.36F) and extreme heat warnings were issued in France as wildfires forced thousands to evacuate Their houses.

In the United States, about 40 million Americans are on heat warnings due to potentially record high temperatures. Utility companies have warned U.S. customers that energy consumption is expected to reach all-time highs this summer, which could put a strain on power grids, according to Reuters. During a heat wave in mid-May in Texas, six power plants experienced outages. At the time, Texans were urged by the electric system operator Electric Reliability Council of Texas (ERCOT) to reduce their energy consumption, explains The Guardian. We ask them to do it again.

As extreme weather events, such as storms, wildfires and droughts, become more common, energy consumption is expected to continue to grow and potentially reach unprecedented heights in the United States this summer. This can put a strain on the electrical networks of utility companies already facing supply chain issues that make it difficult to obtain certain equipment needed to restore power in the event of an outage.

In addition, they are having difficulty replenishing natural gas stocks for the coming winter. This is due to electric generators burning record amounts of gas following the shutdown of dozens of coal-fired power plants in recent years and extreme droughts cutting off hydroelectricity supplies in many western states, such as the noted Reuters.

“Electricity distribution and transmission infrastructure is aging, but utilities have an incentive to invest in it, and they continue to invest, while ensuring their customers’ bills don’t increase by too much every year,” said James Dobson, Energy Strategist, CIO, UBS Americas.

“The challenge in Texas and elsewhere is on the supply side,” he added. “Electricity supply and demand must be equal to maintain system balance. This is the root of the problem. Demand is increasing, but coal plants are running less, renewables like wind and solar which can have variable output have increased significantly, so there is more pressure on the supply side. Utility companies want to invest in their resources to provide a reliable supply. In fact, they are incentivized to do so through state and federal regulations. The challenge is that they don’t want to invest too much because it could make year-round electricity more expensive for their customers.

“A utility company could invest enough to plan for a hot day in July, but customers wouldn’t need those resources at other times, and it would cost more year-round. We want utilities to continue to invest in their infrastructure and have adequate supplies, but there should be a profitable balance. As with many energy supplies around the world, there is a need to simultaneously balance reliability, affordability and decarbonization.

Although utility companies’ valuations are slightly elevated relative to the S&P 500, they have very stable earnings and earnings growth given the regulated nature of their business and the significant resource they provide: l electricity, explains Dobson. He maintains his neutral vision of American public services. This view is underpinned by the CIO’s positive view of the S&P energy sector, which remains premised on increasing US oil and natural gas production, a tight global balance between supply and demand for oil and natural gas, on continued financial discipline that supports increased returns to shareholders, and attractive valuation.

For more information on the energy sector, contact your financial advisor for copies of the reports US Equity Utilities: Equity Preference, US Energy Equity: Equity Preference, and US MLP Equity and Energy Infrastructure: Equity Preference.
Source: UBS