I regular reader asked me to write about how to benefit from the reshaping of the electricity generation business that is now going on because of the increasing demands for power from the fast-growing AI industry.

I have opinions, and I think I understand the main issues. But I should make it clear from the outset that during the almost five decades I’ve been involved with the stock market, utilities of all types in the US have generally been sub-par investments. So although I spent a few years early on analyzing natural gas utilities, I’m not an expert.

My overall conclusion, and what I personally have done, is to find an ETF that focuses on infrastructure for electricity-generation.

Details:

–no one wants five different water or gas or electricity companies to all be digging up the streets to lay delivery networks, most of which won’t be used very effectively. Instead, governments select one provider and require, in return for the monopoly they are allowing, that its charges be regulated by a municipal authority. Typically, the authority sets a maximum allowable annual return on the provider’s investment in plant and equipment. This return is collected as per unit charge added to amounts used by customers.

An example: a utility has plant and equipment of $1,000,000. The regulator allows a 5% annual return, or $50,000. The utility estimates it will deliver 100,000 units in the year ahead. So it adds $.50 to the cost of each unit. At the end of the year, the regulator and the utility reconcile the estimate with what has actually happened. If the utility has collected too little, it will be allowed to raise rates a bit to cover the shortfall. If it has collected too much, it has to lower prices.

–this is inherently a political process. As a result, when a service area is growing and demand for the utility’s output is expanding, the utility commission will most likely grant a generous return on plant. This makes it easier for the utility to raise capital to build out its network.

In contrast, when the area matures–and this has been the case for virtually all of the US for a long time–political mileage will only be made if the utility commission lowers the allowable return. As this occurs, the utility’s focus typically shifts to controlling its own costs. This can include stretching out maintenance schedules or having reciprocal agreements with neighboring utilities that allow each group member to trim full-time staff. Two worries here: customers may turn to other power sources (e.g., solar panels); or the utility may be sued if damage occurs from delivery systems not being properly maintained.

My overall reaction is that this electric utilities are an area I’m not wildly interested in and that there are also lots of ins and outs that can make a substantial difference in potential outcomes for superficially similar firms.

Two conclusions, for me:

–buy a bundle of utilities, not just one, and

–look for equipment suppliers.

Both of these argue, for me, that one should find an ETF, active or passive, depending on one’s risk preferences, that specializes in this area.