While many sectors suffered mightily during the market’s recent decline, utilities largely held their value (See Chart A). But as the economy continues to improve, utility investors are starting to become more selective, shifting their focus toward earnings quality and prospects for future growth.
That’s led to a renewed focus on utilities that are developing or benefiting from high-growth natural gas plays. Diversified firms that have regulated utilities while also participating in the natural gas value chain are seen as superior to pure-play electric utilities because they offer both stability and exposure to growth via rising natural gas demand from a resurgent US economy.
Chart A: Utilities Preserved Wealth During the Market’s Recent Selloff
Created with YCharts In addition to beating the market since the beginning of the year, diversified energy utilities, such as MDU Resources Group Inc (NYSE: MDU), Dominion Resources Inc (NYSE: D) and Sempra Energy (NYSE: SRE), significantly outperformed pure-play or predominantly all-electric utilities, such as Duke Energy Corp (NYSE: DUK) and Entergy Corp (NYSE: ETR), by as much as several percentage points (See Chart B).
Interestingly, among top performers, there was no dominant strategy for exploiting natural gas demand, as these firms were involved in all aspects of the value chain–from exploration and production to distribution and storage. These companies have not only been benefiting from a natural gas surplus, but also from the pressing need to expand US energy infrastructure to deliver this newfound bounty to businesses and households.
Chart B: Diversified Energy Utilities Outperformed Electric-Only Peers
Created with YCharts The abundance of natural gas resulting from the shale revolution could even be a catalyst for US economic renewal, as various sectors of the economy will increasingly rely on the commodity, while there’s also substantial demand for natural gas overseas.
For example, on the domestic front, cheap natural gas is giving various chemical manufacturing industries a new lease on life. According to industry experts, these companies now have a 10-year competitive advantage over their foreign peers. Low natural gas prices have also reduced costs for non-chemical manufacturing firms, enough so that some companies are moving their operations back to the US.
And given proposed environmental mandates to reduce carbon and other emissions, power companies are expected to rely more heavily on natural gas, especially once they have to shutter coal-fired plants to meet more stringent standards.
According to the US Energy Information Administration (EIA), annual natural gas consumption is projected to rise from 25.6 trillion cubic feet (Tcf) in 2014 to 31.6 Tcf in 2040. In the near term, however, demand is forecast to fall by 1.6 billion cubic feet per day (Bcf/d) in 2014, or about 2.2 percent year over year, because of the projected 4.6 percent decline in heating degree days and lower natural gas use by the electric power sector. In 2015, natural gas consumption is expected to increase by 1.4 Bcf/d due to greater demand from the industrial and electric power sectors.
At the sector level, the EIA forecasts that the increase in natural gas prices will cause a decline in demand for the commodity’s use in electric power generation, from 22.3 Bcf/d in 2013 to 21.7 Bcf/d in 2014. But as retirements of coal power plants accelerate in 2015 in response to the implementation of the Mercury and Air Toxics Standards, natural gas consumption will start to rise again, climbing to 22.6 Bcf/d in 2015, and continue to increase over the ensuing years.
Natural Gas: A Long-Term Investment Trend
Even as natural gas prices spiked recently in response to extremely cold weather in the Northeast and other parts of the US, most forecasters predict that prices will level off and remain just above historical lows in the near term. April natural gas futures are trading near $4.60 per MMBtu, well below the high of $5.74 per MMBtu that the spot price hit in early February. That being said, natural gas analysts do not believe prices will fall to the lows seen in 2012.
While diversified energy utilities have been among the beneficiaries of the short-term jump in natural gas prices, investors should focus on the long term. US demand for natural gas is on a steady upward trend, as more and more households, businesses and utilities are projected to switch to natural gas. And once sufficient infrastructure is in place to export liquefied natural gas (LNG) overseas, that will add to overall demand.
According to the EIA, power generation will be responsible for the largest share of demand growth, as usage in the sector rises from 9.3 Tcf in 2012 to 11.2 Tcf in 2040, with a portion of the growth attributable to the retirement of 50 gigawatts of coal-fired capacity by 2021.
In fact, natural gas will eventually overtake coal to provide the largest share of US electric power generation. By 2040, the EIA predicts natural gas will account for 35 percent of total electricity generation, while coal will account for 32 percent.
And as previously noted, low natural gas prices have also fueled demand in the industrial sector, particularly among petrochemical manufacturers. Industrial shipments are forecast to grow 3 percent annually over the next 10 years, before slowing to a rate of 1.6 percent annually thereafter. Bulk chemicals and metals-based durables account for much of the increased growth in industrial shipments in the most recent forecast.
The higher level of industrial shipments leads to more natural gas consumption (including lease and plant fuel) in the US industrial sector, increasing from 8.7 quadrillion British thermal units (Btu) in 2012 to 10.6 quadrillion Btu in 2025.
