You're 3 Scary Steps Away From the Utility Death Spiral

Your energy investment might not make it through the utility death spiral.

Apr 13, 2014 at 1:15PM

The energy sector is in upheaval, and the future of utilities is more unknown than ever. Some analysts are predicting a perfect storm, dubbed the "utility death spiral" by industry insiders. Here are the three scary steps to utilities' demise.

1. Demand growth drops
Unfortunately for energy investors, the death spiral is already under way. Electricity demand growth has been falling since the 1950s, but the Energy Information Administration predicts that the next few decades won't be pretty. Annual increases are expected to clock in around 1% for the next 25 years -- around half that of the 1990s. 

Eia Electricity Demand Growth

Source: EIA.gov. 

For utilities, that drop in demand is all too evident from tumbling top lines. In 2013, some of the biggest utilities around reported slumps in sales. In the past two financial years, as the recovery has lost some of its initial steam, Southern Company (NYSE:SO) sales slumped 3.2%, Consolidated Edison (NYSE:ED) rolled back 4.1%, and FirstEnergy Corp. (NYSE:FE) sales declined a dismal 7.6%.

In a recent survey of utilities professionals, 55% expected minimal growth, while 24% expected stagnant or declining energy demand.

Smart utilities are trying to make more from less, but there's little any investor-relations director can do to make a decline in sales seem anything but bad.

2. Rates rise

Meters

Source: Wikimedia Commons, Leadmaster 

It's counterintuitive, but it's the truth. As demand tapers off, utilities have to actually start charging more.

While that does little to incentivize electricity use, it's the only way corporations like Southern Company, Consolidated Edison, and FirstEnergy Corp. can maintain their massive infrastructure. In a nutshell, every consumer has to carry a bigger burden of distribution costs.

According to government data, while U.S. retail sales have increased just 19.5% over the past decade, prices have soared 34.6% to 9.8 cents per kWh. Even so, Consolidated Edison, has a $10 billion work backlog on its aging New York City pipeline system, Southern Company is trying to cover unexpectedly high construction costs for a new plant, and FirstEnergy. Corp needs more cash to convert its coal fleet to something cleaner.

3. Credit downgrades

 Money Burn

Source: Flickr, Images Money. 

As demand growth drops and rates rise, consumers start to think much more critically about their energy use. Whether it's adding on a SolarCity Corporation rooftop solar system, or installing Google's "Nest" household energy efficiency technology, customers aren't going to sit back as their power bill balloons.

For utilities operating on an age-old system of big projects with big debt, that spells disaster. Lower sales from distributed generation and energy efficiency improvements means creditors are going to be more leery than ever to make large loans to utilities.

Energy companies can expect the cost of capital to increase, which makes it pricier than ever before to take on debt, even if it's to overhaul a bad business model. The utility death spiral is complete.

Get out now?
While a "utility death spiral" hardly sounds like an investing opportunity, it is. The energy sector is undergoing an unprecedented revolution, and companies with a progressive outlook and fast-acting adaptation are going to emerge as the ultimate winners.

While steady earnings and long-lasting dividends are no longer a guarantee across the industry, there's more profit opportunity than ever before for smart investors.

3 stock picks to ride America's energy bonanza
Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, The Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free.

Justin Loiseau owns shares of Google (C shares). The Motley Fool recommends Google (A and C shares), SolarCity, and Southern Company and owns shares of Google (A and C shares) and SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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