Electric Utility Sector: Balancing AI-Driven Growth and Carbon Emission Challenges

Electricity utility companies have long been a reliable choice for investors, known for their stable income and consistent dividends. However, since 2020 they have experienced underperformance and diverged from S&P 500 total returns. This sector hasn’t quite kept up with its historical performance levels, but fortunately there's renewed optimism on the horizon.

The resurgence of the global economy from the impacts of COVID-19 and the easing of high interest rates that previously led investors towards high-yield bonds are indeed placing electricity utility companies in a favorable position. The increasing energy demand driven by AI and data centers strengthens their outlook further, suggesting they might be set for improved success.

However, alongside these positive factors, the industry is also facing challenges, particularly with the rising cost of carbon emissions. That can impact operating costs and regulatory compliance, which are significant factors for utility companies as they navigate the transition towards cleaner energy sources and sustainable practices.

Figure 1: Total Return on S&P 500 vs. U.S. Electricity Utility Companies Selected from MSCI AC World Index

The IEA reports that electricity demand driven by AI and conventional data center services is expected to increase sharply, with global server capacity projected to double by 2026. In 2022 data centers, AI, and cryptocurrencies collectively consumed approximately 460 terawatt-hours (TWh) of electricity, accounting for just under 2% of global electricity demand.

There are more than 8,000 data centers worldwide, with 33% in the United States, 16% in Europe, and around 10% in China. In the U.S., electricity usage by data centers is projected to grow rapidly, from about 200 TWh in 2022—representing about 4% of the nation's electricity demand—to nearly 260 TWh by 2026, which would then account for 6% of total demand.

The growing demand for electricity due to increased computing power presents notable challenges to infrastructure and resources. The current electricity grid could face difficulties managing the surge, potentially leading to overloads and supply reliability issues. Furthermore, local water resources might not be adequate for cooling data centers. Power plants that burn fossil fuels would exacerbate the environmental impact through their increased carbon emissions, thereby raising operational costs for companies.

In this proposal, the examination of carbon emissions as a potential carbon liability for U.S. electricity utility companies centers around the analysis of two key datasets. The first dataset, sourced from FactSet Deep Sector Power Plants, provides insights into the generation capacity of each power plant, categorized by different energy sources. This allows for an assessment of each company's energy mix when operating at full capacity.

The second dataset, from FactSet Carbon Diagnostics (powered by Emmi), serves to evaluate the potential carbon liabilities these companies may encounter. This is assessed based on the companies' individual carbon emissions, which are a proxy to their specific energy mix capacities in electricity generation. By analyzing these datasets, the study aims to illustrate how unmanaged carbon emissions could pose significant liabilities to these utility companies if not addressed effectively.

The potential carbon liability for each scenario provides a valuable framework for assessing the potential impacts and risks associated with different climate outcomes through the use of carbon pricing. This approach helps quantify the financial consequences for companies that exceed their carbon budgets. Essentially, it measures how much a company might lose in value if it fails to adapt to the transformational changes prompted by climate change.

Figure 2.1 shows companies with a high renewable energy mix generation capacity generally report lower potential carbon liabilities (PCL). For instance, Edison International, Eversource Energy, PG&E Corp, and NextEra Energy feature renewable energy proportions of about 79%, 100%, 77%, and 49%, respectively. These figures are based on their total generation capacity, including other energy sources like coal, oil, and gas, and are used as a proxy for the companies’ carbon emissions.

In contrast, companies with a lower renewable energy mix generation capacity, face a 100% potential carbon liability. This indicates a risk of value erosion if they continue their greenhouse gas emissions under a business as usual operational model based on the carbon budgets of NGFS net zero scenario for the current year, 2030, and 2050. Moreover, you can also spot the increase in percentages of potential carbon liability over time as the global carbon budget shrinks according to the scenario with high carbon prices to incentivize the companies to transition, showing stricter policies to meet climate targets.

Figure 2.1

Figure 2.2 

When comparing companies within the NGFS 2 degree scenario, we observe those with a higher renewable energy mix generally exhibit lower potential carbon liabilities, as illustrated in figure 2.1. It is important to note the differences in PCL magnitudes between the NGFS 2 degree scenario and the NGFS net zero scenario. The former scenario assumes a gradual increase in the stringency of climate policies, leading to a relatively lower shadow carbon price.

In contrast, the NGFS net zero scenario envisions more stringent climate policies with rapid adoption of technology and innovation. For example, Constellation Energy is projected to face a 100% PCL under the NGFS net zero scenario for the current year, indicating a significant potential loss in company value. However, in the NGFS 2 degree scenario, its PCL is reduced to 27%, highlighting the impact of comparatively lenient policies.

U.S. electricity utility companies are poised to address the increasing electricity demand spurred by AI computing and data centers, creating significant opportunities for revenue growth and profitability. However, as the industry evolves there is heightened consumer demand for more affordable and cleaner energy sources.

The shift is reflected in the approaches of tech giants such as Microsoft, Alphabet, Amazon, Apple, and Meta, which are working toward sustainable electricity supplies. While addressing potential carbon liabilities may not resolve other energy supply challenges like grid constraints, battery storage, and cooling issues, current trends highlight the importance of cost-effective energy generation in some sectors. From the perspective of carbon pricing, those who effectively manage these factors could gain a competitive edge and potentially exhibit superior performance over time.

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.