Watch out! Those “safe” utility stocks that you might be relying on for juicy dividends likely won’t be so reliable forever.
The heavily regulated industry is ripe for technological disruption in the same way that the music business, the news media and book publishing were upended over the last couple of decades. As with all disruption, there will be winners and losers.
The change could be great for consumers, but investors need to be aware of how it might alter the relative attractiveness of different types of stocks.
[See: 10 Best ETFs for Large-Cap Stock Growth.]
For instance, the stocks in the Utilities Select Sector SPDR exchange-traded fund (ticker: XLU) have an average dividend yield of more than 3 percent, versus dividends of close to 2 percent for the Standard & Poor’s 500 index.
How long those outsized dividends last will in large part depend on the speed of the disruption.
Cheaper batteries are needed. “The storage piece is the game-changing piece that could disrupt the utilities,” says Divya Reddy, director of global energy and natural resources at Eurasia Group in the District of Columbia.
While solar panels are readily available for installation on top of a home, they can’t provide any electricity at night. The solution is to have a battery to store power during the daytime for use later. But the cost of battery technology to store the power is too high and will need to drop substantially to make it economical.
“It’s probably more like a 20-year than 10-year time horizon (for prices to fall),” Reddy says. “If there is a breakthrough on the storage technology, it could be faster.”
Certainly, Tesla Motors (TSLA) and its CEO, Elon Musk, are doing their part to push the technology faster.
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A vicious cycle for utilities. When those batteries become smaller and cheaper, more people, especially in sunny areas, will literally go off the electric grid. That presents a potentially massive problem for utilities, which have huge fixed costs of maintaining power lines and a grid system.
The fixed costs are spread among large numbers of customers, with each household or business paying a small monthly charge regardless of how much energy they use.
Imagine if half of the customers just disappear because they’ve opted to generate their own electricity from rooftop solar panels. If that happened, the fixed costs at the utility would have to be spread among the remaining customers.
In this example, remaining customers would see the fixed portion of their bill double, which would in turn give the remaining customers an incentive to opt for the solar technology. This is what economists would call a vicious cycle.
“Slowly but surely, (utilities) will lose their monopoly power,” says Barry Ritholtz, a Wall Street veteran and chief investment officer of Ritholtz Wealth Management in New York.
[See: 7 Stocks That Will Ruin Your Portfolio.]
Watch the energy market. The move to solar is in some way dependent on how the other energy markets, such as natural gas, coal and oil perform.
“History has proven that energy technology can move very quickly when there is an economic incentive,” says Travis Miller, director of utilities equity research at Morningstar. “A significant change in the energy markets could speed that process up very quickly.”
It’s not unrealistic to think that such a change could come quickly.
Natural gas prices have sunk to less than $2 per million British thermal units, down from more than $4.50 in mid-2014, according to data from the U.S. Energy Information Administration. Prices fell quickly, and they can rally fast as well. Other energy costs have moved rapidly also.
The higher the prices, the more incentive for customers to switch to solar power. And the upending of the utility business model will affect consumers and the companies themselves.
Utilities companies, at least the smarter ones, will need to adapt. Some are already doing so, Miller says. “To the extent that a utility can be a service provider, it could be a huge investment opportunity,” he says.
Miller sees a situation where companies help customers manage their energy needs by offering advice and installation of things like thermostats and smart meters that cut usage of power when it’s not needed.
That energy efficiency service would be the sort of thing that even households who stay on the grid would benefit from through reduced bills. And it’s the type of utility offering that will distinguish the winners from the losers in the power business.
Some companies already see the writing on the wall for the industry, Miller says, with NRG Energy (NRG), Exelon Corp. (EXC) and Centrica among those that are innovating in the field.
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Say Goodbye to Utilities Stocks as We Know Them originally appeared on usnews.com
