RELIABLE POWER-THE NEW REALITY "ADV" | CROUCH CONNECTION, FEBRUARY 2021
RELIABLE POWER – THE NEW REALITY
Most of Middle and West Tennesseans have been confined to quarters by the recent snow and ice for the past few days. Our friends in Texas, unfortunately, were much more severely impacted by the record polar vortex. The freezing weather and ice caused electrical blackouts that left millions without electricity for days.
There is a lesson for us in their misfortune that applies to investing…now, more than ever, we realize how dependent we are on RELIABLE electric power.
THE INCREASING IMPORTANCE OF ELECTRIC POWER
For many years we have believed that regulated utility stocks are an important component of income-producing portfolios because of the unique features of utility companies. According to Investopedia:
“Utility companies for gas, electric and water, and other forms of power often operate with the protection of government regulations that act as barriers to entry in a market. Shielded from competitors, utilities can establish themselves as a dominant force in an entire community, state or even region.”
That’s what Warren Buffett calls a “competitive moat”, one of the most important qualities that a company can have. In addition, utilities tend to be very resistant to economic cycles because demand for utilities does not change much. With consistent demand for their product, utility companies can often afford to pay consistent and high dividends to their shareholders.
Sounds like a perfect investment so far, right? Well almost. Unfortunately, like any other sector in the market, investors can fall in love with the utility sector from time to time and bid the prices too high. So occasionally utilities take a dip as well, but usually it does not happen at the same time other sectors fall out of favor, providing a cushion during many market corrections.
Currently our world is facing two major developments that are destined to change our lives as well as our investments for many years to come. Both are destined to positively impact the utility industry for many years to come and promise to be extremely positive for utility investors.
In the first, our automotive industry is undergoing a revolution with electric-powered vehicles touted as the answer to many problems the world seems to face. All the major manufacturers are racing to bring all-electric vehicles to the market in an effort to meet the unexpected demand created by the phenomenal success of Tesla and its extremely successful line of cars. This additional demand for electricity could be very positive for the electric utility industry.
By my math, if every family in the US replaces their gas-burner with an electric car, the average family electric bill will increase by about 25%. Official estimates vary, but Toyota President Akio Toyoda recently stated that Japan would run out of electricity in the summer if all cars were running on electricity. Electric utilities will most likely be selling a lot more electricity as America converts to electric vehicles.
The second revolution sweeping our nation is the war against global warming. I will avoid the debate about the existence of global warming because there are passionate believers on both sides, but I think most of us can agree that the world is demanding that we reduce our production of carbon dioxide which is being produced by the burning of fossil fuels.
In addition (to state the obvious), because of the recent elections, the next four years will most likely see many changes in government regulations designed to combat the global warming monster. Automobiles, trucks, trains and airplanes are seen as a major source of carbon dioxide, so naturally electric vehicles are seen as part of the answer to the climate change problem.
Another source of carbon dioxide and therefore in the crosshairs of climate activists is the utility industry. Burning coal, until recently our most important source of energy, causes most of the pollutants produced by our electric utility industry. The conversion of electric generation from coal to cleaner solutions is highly favored by activists, so state regulators have been offering financial incentives to the utility companies progressing in that direction.
The rapid reduction in the cost of solar arrays and windmills has made the power produced by these “renewable” sources cost competitive with traditional generation practices. Regulators also have favored these alternatives in recent decisions, and there has been a new focus on and much progress by the electric utility industry to build large-scale solar and wind farms. Climate activists have promoted “renewable” energy as the perfect answer to our fight against global warming, and there were many believers…until last week!
Texas, with its power system separated from the rest of the US, leads the nation in wind generations and the addition of large-scale solar installations. The regulatory structure in Texas does not provide any incentives for the power producers to build any excess capacity, so they had very little margin for error, and the polar vortex decimated the system. This regulatory structure is the reason we have never recommended investment in any of the Texas-based utility companies.
If you have followed the news very closely, you know that the “renewable” energy sources did not perform very well during the demand surge caused by the unusual weather of the past week, leaving millions of Texans without electricity. There were also problems with many natural gas plants that weren’t equipped to deal with the extreme cold and a nuclear plant whose water supply froze causing a shutdown.
With the exception of solar, most of Texas’ power problems can be corrected with additional equipment to winterize the facilities. All Americans, however, have been reminded how important it is for us to have a reliable power supply and how critical our power industry is our daily lives. There is now no doubt that utility companies are critical to the future of our nation and our economy.
They have already received favorable treatment by regulators encouraging the construction of renewable and lower carbon power plants, and we expect that trend to continue and possibly accelerate. The financial incentives they receive to construct these new facilities will be very positive for the companies.
As an industry, utility companies face a bright future, and this bodes well for their investment prospects. For many investors, we favor investment portfolios built around a core of utility stocks based in business-friendly states. We look forward to sharing more details about our selections in our meetings this year.
Registered Principal Branch
Warren Buffet Quote:
"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Dave Crouch and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.