Flat Electricity Demand Sounds Horrible For Utilities: But Guess What?

In what looks like man-bites-dog report, the U.S. Energy Information Administration (EIA) estimates that electricity use in America will barely grow in the next 30 years, despite the current economic recovery, expected population growth and our love of electrical gadgets.

The agency projects annual growth rates of 0.6% in electricity consumption by industrial users and 0.7% by residential users between 2011 and 2040. After climbing 4.4% in 2009-2010, annual electricity generation by industrial, commercial and residential users edged lower in 2011 and likely slipped again in 2012.

Residential, commercial and industrial consumers are using less power and finding alternatives to their local electric utility. Electricity generation is not rebounding from the recession as strongly as the history of post-recession periods would predict. The flattening slope of the accompanying chart of monthly EIA data, if you ignore seasonal swings in electricity generation, illustrates the point.

US Electricity Net Generation Chart

US Electricity Net Generation data by YCharts

The recent onset of consumers apparently turning down the juice affected financial results of all major electric utilities in 2012. A flat market for electricity sounds bad for electric utility investors. Energy giant Chicago-based Exelon (EXC), one of the companies hurting from low energy prices, told shareholders in November that its dividend is in jeopardy. Little wonder the current Exelon dividend yield is above 7%.

But all is not as one would expect. A weak demand trend, oddly, makes things easier for utility company investors. Expenses, which management controls directly, become relatively more important than revenues, which vary with energy market prices, over which management has limited control.

When demand growth weakens, expenses which management can control become more important relative to revenues, which vary with energy market prices. One way to judge expense control in a flattening product market is the change over time in a company’s operating margin, which measures how much each dollar in revenues contributes to a dollar in operating profits. Since electricity consumption began to flatten and the cost of natural gas as an electricity generating source has fallen, Wisconsin Energy (WEC) has shifted its generating capacity toward natural gas away from its principal source, coal. In the first nine months of 2012, company’s retail megawatt electricity sales slipped, led by a 3.3% drop in sales to large commercial/industrial customers. But the cost of fuel for making electricity dropped 6%, helping to boost the period’s operating margin.

WEC Operating Margin TTM Chart

WEC Operating Margin TTM data by YCharts

At Exelon, operating expenses in the first nine months soared 37%, thanks largely to two big acquisitions in 2012, Baltimore Gas & Electric Co. and Constellation Nuclear Energy Group. Through the first nine months of the year, neither acquisition contributed to a gain in megawatt sales. Exelon revenues grew by 17% but its cost of fuel climbed 26%, in part reflecting higher nuclear energy costs.

Wisconsin Energy shares are pricey, based on a PE ratio using the current stock price and the average of the last ten years’ earnings per share. But long-term investors can take comfort in the company’s operating margin expansion amid the EIA’s long-term forecast of flat electricity demand and the company’s comfortable dividend payout ratio of less than 50% of earnings. Wisconsin Energy's dividend yield is a more reasonable 3.6%.

WEC PE 10 Chart

WEC PE 10 data by YCharts

Bill Barnhart, a contributing editor at YCharts, is a 36-year veteran of business reporting. Most recently he was the financial columnist for the Chicago Tribune, where he offered daily commentary on financial markets. He is a past president of the Society of American Business Editors and Writers. He can be reached at editor@ycharts.com.

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