Smart Investing in the Smart Grid

By Julian Murdoch

President Obama made the overhaul of the nation's electrical infrastructure a vocal part of his 2008 campaign. In an interview with MSNBC's Rachel Maddow just days before the election, he outlined his promise of involvement:

"One of, I think, the most important infrastructure projects that we need is a whole new electricity grid. Because if we're going to be serious about renewable energy, I want to be able to get wind power from North Dakota to population centers, like Chicago. And we're going to have to have a smart grid. If we want to use plug-in hybrids, then we want to be able to have ordinary consumers sell back the electricity that's generated from those car batteries, back into the grid. That can create 5 million new jobs, just in new energy.

But, it's huge projects that, generally speaking, you're not going to have private enterprise would want to take all those risks. And we're going to have to be involved in that process."

Last week, the administration finally made good on its promises, announcing an award of $3.4 billion in grant money to 100 cities, utilities, equipment makers, systems developers and other organizations around the country (out of 390 applications). The grants were awarded in six different project areas: advanced metering infrastructure, customer systems, electric distribution systems, electric transmission systems, equipment manufacturing and integrated and/or crosscutting systems.

Ranging in size from just under $400,000 to $200 million, each grant represents only a fraction of the proposal's estimated cost. But in every case, there are matching resource commitments from other sources, bringing the actual fully funded investment from the program to over $8 billion.

Source: U.S. Department of Energy

The projects are all over the map—both literally and figuratively. Rather than a government handout to a few obvious, entrenched players, the funding will be sprinkled across multicompany collaborations and private/public partnerships.

In particular, the money will buy millions of smart electric meters at a hodgepodge of utilities, pushing new tech into the field and even newer tech out of the lab and into commercial testing. Some awards even fund security research on how to prevent terrorist attacks on this new smart grid.

With all of these new projects starting, what's it mean for commodity investors?

Smart Grid's Ripple Effect On Demand

For commodity investors, the development of a smart grid in the U.S. is all about ripple effects. The Electric Power Research Institute has estimated that smart grid technology will allow consumers to reduce electricity demand by 4 percent by 2030—which will mean less demand for coal and natural gas for electricity production.

In fact, if smart grid technology delivers as theorized, demand for natural gas could decrease disproportionately to that for coal, since natural gas is the go-to fuel used to create additional electricity during summer's peak use times. A smart grid, however, would smooth out these peaks by changing consumer behavior, through better data and higher fees for usage during these times; this, in turn, would lower demand for natural gas as a result.

But let's be realistic: While globally important, a theoretical 4 percent reduction in demand over 20 years isn't going to make a tremendous difference in the price of natural gas at the Henry Hub in Erath, La., next week.

Playing The Smart Grid: Stocks Vs. ETFs

The traditional, obvious way to play "big news" like this would be to run through the winners list (or you can cut to the chase and read through Jeff St. John's excellent recap of the investable winners at Greentech). The list is a who's who of utilities and tech providers: Southern Company (NYSE: SO), Centerpoint Energy (NYSE: CNP), FPL Group (NYSE: FPL), Exelon (NYSE: EXC) and so on.

But it's also a long list, and given the collaborative nature of most of the projects, trying to "chase the list" and determine which company will benefit out of proportion to the others seems like a bit of a mug's game. There are, however, ways to make the play without the guesswork and legwork: ETFs.

Unfortunately, though, there are no pure plays. The ETF most often cited when mentioning smart grid technology is the PowerShares Cleantech Portfolio (NYSE Arca: PZD), which holds 77 companies, ranging from giant industrials to small biofuels firms. PowerShares' other related "green" ETFs, like the PowerShares WilderHill Clean Energy ETF (NYSE Arca: PBW), suffer from similar dilution issues.

Another option is to focus on individual sectors, such as alternative energy producers or utilities. For example, playing an alternative energy fund like the Market Vectors Global Alternative Energy ETF (NYSE Arca: GEX) gets you access to the major wind, solar, hydro and energy-efficiency players all at once. Or you could invest in a utilities ETF like the Vanguard Utilities ETF (NYSE Arca: VPU), which holds several of the big winners from last week's announcements.

Chasing The List?

All that said, I'm reluctant to suggest chasing government funding. While the long-term success of the smart grid will indeed have real, positive impact on the global economy, the short-term impacts on individual companies and commodities is unpredictable. For example, the announcement of a $200 million grant to PECO did nothing for parent company Exelon's stock last week, which remained depressed from a mediocre third-quarter earnings report.

For the most part, the smart grid will be implemented by behemoths in the utilities space, which are bought and sold for their traditional, income-heavy businesses. Yes, there will be some smaller, scrappier winners (and losers), just as there are in every industry. But betting just based on who got a grant? I'd rather stick to my indexes.

Comments

[bluesky123:]

if Wall Street wishes to redeem a modicum of respect from Americans, Wall Street should create a financing plan to build America's new grid. Divide the country into sections and cobble together investors who fund the grid construction for each section. The investors are public and private investors, pension funds, equity investors, debt investors etc. Finally do something for America all those of you who took all of our money.

Nov 04 04:18 AM

[predictorma...:]

One smart grid speculative play is SATC, which makes power inverters. Has had a bit of a rough time making their numbers over the last year or so, but is reasonably priced and could double.

They currently have a decent revenue stream, have expenses in line, and are past their "dilute to gain some cash" phase.

It could also go nowhere, but as I said, it's speculative.

Nov 04 08:42 AM

[occupant:]

I can not wait to get my smart electric meter that here in texas is being shoved down our throats. Lets see first you charge me for the new smart meter which then tells you what you already know-when peak usage is. Now you can set the rates to charge individual people more money during peak usage and you package it by telling the masses how great variable rates are through a 24 hour period. I am sure the we can adjust and will be cooking dinner and washing clothes at 3am

Nov 04 08:49 AM

[Ferdinand E...:]

When folks start talking about smart grids, I reach for the sleeping pills.

Nov 04 09:13 AM

[richjoy403:]

Bluesky--I don't want wall street to be doing anything that doesn't make sound economic sense (that is not the way to "redeem a modicum of respect from Americans", and lead to the stupid financial products we are trying now to put behind us).

OTOH, developing a financing product for needed infrastructure is one of the things wall street does (and always has done). So, if the THRUST of your suggestion, rather than the details, does make economic sense, it is quite likely to happen.

Nov 04 09:17 AM

[danno:]

Nice article, but I have some issues here.

Many of the utilities and ISOs in particular, have been real foot draggers when it has come to smart grid, competition, de-coupling, etc. which are key issues here. I'm not sure I'd like to be investing in utility industry particularly with its legacy "we're still a monopoly so screw the customer" mentality. Also any rate increases still need political approval which is a real political hot potato.

I am an investor in PZD, and it doesn't have or hasn't had investments in "tiny biofuel companies" for long time. If it did, I'd probably dump it. So you are off the mark on that description.

I would think the best pure plays of public companies for smart grid are Telvent and MYR Group. Otherwise what I see is a business that will be dominated by giants like ABB, Siemens, Honeywell, GE, Schneider, IBM, Johnson Controls, Cisco, etc. but the best technology is still with many non-public companies like Silver Spring Networks, Fat Spaniel, BPL, C-Powered, Eka Systems, etc.

That said, I wouldn't want to bet on any of the public companies individually, because they are very diversified and don't have enough exposure overall to the Smart Grid. PZD seems to have the highest exposure to this "sector", at about 12% or so, but I think it avoids companies in industries that are doomed, too. such as grain-based fuels and "clean coal". I think that it's easier to outperform by avoiding investing in what you know is doomed and focusing on sectors that you know will do well such as smart grid, energy efficiency, or water purification technologies. Avoiding the dogs is half the game, and there don't seem to be too many dogs in smart grid, yet.

Nov 04 10:41 AM

[U338129:]

Stick with EXC folks. Not only do you get the wind energy aspect(take note, if you read the recent reports from EXC they are not projecting a big build out for wind in the near-term) but you get the nuclear as well as the company with the lowest carbon footprint around (cap and trade anyone). All of that signals not only somewhat consistent/reliable returns and cash flow, but a very high likely hood of direct benefit from administrative action to help solve the energy issues in the U.S.

Plus, if you look at their most recent debt maturity profile (phx.corporate-ir.net/E...), you'll notice that the debt they have is spread out all the way through 2039. Additionally, the highest payout they have in any given year appears to come in 2018 at just below $1.4 billion with most years well below that. To me, that's pretty conservative financing for a utility company.

I will also add that I really like the dividends from this. My entry point was low $46 and I've been pleased (those that bought at the $90 range probably have a very different view;)).

Nov 13 08:20 PM

[Fortuno:]

Ferdinand...sleeping pills? Are you kidding?

Apparently Google and Microsoft think it's worth building a software layer on top of the smart grid. And Cisco is diving in...The smart grid will drive the ecological economy of the next decade. If you're taking sleeping pills right now I liken that to a person who said, "domain name? why do I need one of those?" in the early nineties. Sleep away....

I like EXC and ELON. GridPoint, Tendril and Silver Spring are doing some cool things in the private sector...

Nov 15 11:03 PM