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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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U.S. Utilities Desperately Need To Spend More On Energy Infrastructure

  • According to industry documents, electric companies spend around one-third of capital investment on meeting growth.
  • The Inflation Reduction Act will help to finance the shortfall in utility capex.
  • The principal obstacle to rapid electrification of the economy may not be a lack of lithium, copper, or cobalt but rather of infrastructure.

Since the 1970s, energy has played a diminishing role in economic growth with the offshoring of industrial production sometimes cited as a reason, but increased energy efficiency is the more likely culprit for the decline in energy intensity. Hard to believe, nowadays, but we would argue that current circumstances will reinforce the trend, at least for fossil fuels. What rational player would want  a repeat of 2022?) But that’s not the topic today.  In 2000-2020, both worldwide and in the U.S., energy consumption grew more slowly than the real gross domestic product (GDP). Electricity consumption grew faster than energy consumption, but much more slowly than GDP. Meaning— the economy found ways to use both energy and electricity more efficiently. Those trends prevailed in both the U.S. and globally, indicating that we cannot attribute them just to the offshoring of U.S. industry alone. These trends in energy consumption happened all over. 

Figure 1 shows annual growth rates for the world.  

Figure 1. Annual rates of growth 2000-2020 for world (%)

The U.S. starts from a different place than the rest of the world in that it has already made a transformation into a modern economy, as can be seen in Figure 2. Or to put it another way, the U.S. uses more than twice as much energy to produce a dollar of GDP compared to the world as a whole. So it has plenty of room to trim out waste and still show economic growth. 

Figure 2.  Annual rates of growth 2000-2020 for USA (%)

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Of course, the real question is where are we going, not where we were. All major government and international agencies agree that the population will increase at a slower rate and will age, both factors likely to put a damper on economic growth and energy consumption. Based on numbers from the World Bank, IEA, OECD, IMF and similar sources, we believe that Figure 3 presents a consensus for world growth rates over 2020-2040. 

Related: The World’s Energy Problem Is Far Worse Than We’re Being Told

Figure 3:  Annual rates of growth 2020-2040 for world  (%)

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The USA’s numbers, from the Commerce Department, the EIA, DOE and NREL, and other official sources, look weaker, with population growth especially so, as shown in Figure 4.

Figure 4. Annual rates of growth 2020-2040 for USA (%)

Energy companies, given the capital intensity of their assets, have to plan ahead. Refineries, power plants, pipelines and offshore drilling platforms take years to put in place and are built to meet expected demand for decades. Build for 1% growth and consumers want 2%, and prices have to rise due to the imbalance of supply and demand. If the oil companies underbuild, they will earn more from scarcity and the resulting higher prices. The industry’s leaders can’t have any illusions about market share. They will lose market share, starting in transportation with the rise of electric vehicles,  for example. So why invest more capital than necessary to serve a slow growing (and potentially declining) market? If on the other hand electric utility companies underbuild in the face of likely growth, they will throttle the effort to electrify the economy in order to combat global warming. We sense that major European utilities, such as Enel, Iberdrola,  and SSE see decarbonization as a business opportunity and are building for it.   

U.S. utilities, we believe,  are building for an expected 1% growth, the consensus rate for many years. Now, here’s the rub. If within 20 years, the vehicle fleet (cars and trucks) becomes battery powered, air conditioning load increases significantly due to a 1.5 degree Celsius temperature increase, and if the industry electrifies certain manufacturing processes (for instance, in cement)—kilowatt hour sales would rise 47-50% above estimated levels. This would add a substantial 2% per year to the current expected growth rate. That is, electricity sales growth would increase from 1% to 3%. Now, that does not sound like much, but it trebles the growth rate. Stated differently, the electric industry hasn’t seen this growth rate since the stock market days of the Nifty Fifty (early 1970s) and perhaps more importantly, none of the industry’s executives has ever seen or managed through a growth rate of this magnitude. Electric companies, among the most capital intensive businesses in existence, must invest large sums well in advance of growth or they won’t have the capacity to serve their new and increasing load.   

Now for the problem, or maybe the question. According to industry documents, electric companies spend around one-third of capital investment on meeting growth. In the past decade, the capital expenditure program of investor-owned utilities rose about 40%, or at about the same rate as construction costs. So it is difficult to make the case that the industry is revving up its efforts to anticipate a climate-related increase in demand.

If the industry has underestimated its growth, then by how much is it underspending its capital needs? Maybe a minimum of $50 billion per year is our rough guess. The Inflation Reduction Act will help to finance that shortfall, but remember that a lot of that aid comes in the form of credits after the investment is made, while some of those benefits will flow through to consumers. (The IRA might take care of two years of extra spending needs.) And the next question is do our domestic utility companies still have the financial foundation and resources to undertake the construction and operation of massive new infrastructure projects? We will address that next week.

If we are right, though, the principal obstacle to rapid electrification of the economy may not be a lack of lithium, copper, or cobalt but rather of infrastructure. We won’t be able to blame striking Chilean or Congolese miners or state owned companies in China or Putin’s belligerent antics for that.

By Leonard Hyman and William Tilles for Oilprice.com

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