The Smart Grid: Is It Finally Time To Invest?

 |  Includes: ABB, AEE, BA, ETN, EXC, IBM
by: Blake Tyler

With technological evolution comes an increased dependence on stable energy production and transmission. Not having undergone large scale infrastructural improvements in over fifty years, the American energy grid is due for an overhaul that accounts for modern demand. For example, the average age of a substation transformer in the United States is two years older than its design life. Despite comparatively little utility research and development, the nation's electricity demand continues to rise. Without updating the energy grid to accommodate growing demand in a digital age, energy shortages and transmission inefficiencies threaten power availability and contribute to rising costs. The Illinois 2012 Smart Grid Market Inventory estimates, "Each year power outages and interruptions across the nation cost at least $150 billion, or about $500 for every single American". Meeting these challenges requires government and utility collaboration to determine the alignment of private and public interests.

The smart grid industry will undergo inevitable growth, but finding investment opportunities is contingent on timing the infrastructural transition. A means of bringing together the elements necessary to ensuring long term energy sustainability, a smart grid efficiently distributes and manages a diversified energy infrastructure. Its adoption will be demand driven, and is likely to evolve from the ground up. While the Obama Administration allocated $3.4 billion under the 2009 stimulus package to support research and development, the grid's implementation will occur at the state and local level. On a smaller scale, policy makers and utilities can more effectively account for local irregularities when calculating smart grid investments. This ensures more stable market growth.

In 2009, IBM's venture capital group (NYSE:IBM) committed $2 billion to smart grid start ups as a complement to Federal stimulus. Despite limited evidence of consumer demand, other big tech companies also invested. While they correctly recognized the smart grid's inevitability, they embraced unfounded expectations for short term implementation. A Discussion Paper published by the Canadian Electricity Association compares smart grid evolution to the 1990s internet bubble. It argues that "large movements of technological change are almost always over-promised and under-delivered in the first several years of implementation". As with the internet, early smart grid investors assumed an unrealistic rate of infrastructural change. Consequentially, big tech companies and venture firms made investments that failed to pan out as originally expected. The classic change curve below illustrates these expectations followed by a correction prior to a steady positive performance.

Click to enlarge

Fortunately, legislation in Illinois suggests that smart grid implementation is emerging from the Valley of Despair. Recent policy facilitates the energy transformation by permitting utilities to make long term investments in smart grid technology. The Illinois Energy Infrastructure Modernization Act, passed in 2011, empowers the state's largest utilities, Commonwealth Edison and Ameren (NYSE:AEE), with the authority to raise $3.2 billion for updating the state's energy infrastructure over the next ten years. While the Act will raise rates on consumers in the short run, it will fund investment that is expected to create 2,400 jobs statewide. While Illinois is geographically advantaged as a midwestern hub with developed wind resources, other states have made similar efforts to modernize their energy infrastructure. As renewable energy grows, the irregularity of wind and solar will require an energy grid capable of distributing and storing power in accordance with consumer demand.

Illinois' efforts to become a smart grid leader are an indication that policy makers, utilities and consumers are prepared to take a collaborative approach to smart grid expansion. Boeing (NYSE:BA) and Commonwealth Edison see opportunity in the Illinois initiative, and are spending $10.4 million developing an energy distribution and management system designed to maximize energy efficiency and value for consumers and utilities. On the energy storage side, Mitsubishi Motors is working with Eaton Corporation (NYSE:ETN) to install a recharging infrastructure for its electric vehicles. Smart grid expansion has also promoted renewable growth. Exelon Power (NYSE:EXC) has spent $10 million building a 10 MW solar project in Chicago, and the state's wind industry continues to expand. Since the legislation, 13 of the state's 31 Fortune 500 companies have begun working on projects that contribute to the smart grid. For a complete list of the companies contributing to the Illinois smart grid consult page 39 of the 2012 Smart Grid Inventory Report.

What it means:

According to the 2012 Report, "The worldwide smart microgrid market, valued at $4.14 billion in 2010, is projected to grow to $7 billion by 2014". Further, North American companies appear to have a competitive advantage in microgrid innovation. In 2010 they dominated almost 74 percent of the global market share. There is a definite need for an updated infrastructure, and the global tendency to digitize basic services suggest that it is only a matter of time before we realize a "smarter" electricity grid. While Illinois is the self proclaimed leader in smart grid implementation, other states ((California, Colorado, Florida, Massachusetts, New Jersey, New York, North Carolina, Ohio, Pennsylvania and Texas)) have passed policies intended to facilitate a smart grid transition. Local efforts have ramped up, and according to the American Council for an Energy-Efficient Economy, last year Massachusetts passed California as the most energy efficient state. In 2010, total state budgets for energy efficiency programs grew to $4.5 billion from just over $3 billion the year before. The 2009 hype around smart grid technology seems to have been replaced with a steadier, more pragmatic approach that accounts for consumer and utility interests.

A more pragmatic approach suggests that utility investments will be focused on components of the smart grid most acceptable to consumers. Given backlash to Smart Metering in California, utility investments in Distribution Automation (DA) is more likely. Defined by Silver Spring Networks as "two-way communications with the protection and control devices on the distribution portion of the smart grid", DA allows utilities to improve distribution efficiently and reliability. Unlike Smart Metering, its implementation is unlikely to instigate social opposition. This makes its approval politically safe for state policy makers and appealing to utilities looking to reduce long term costs and to rebuild energy infrastructure. DA technology providers stand to benefit from political support and utility investment. Born within a cultural context that emphasizes energy sustainability, the Swiss technology provider ABB LTD (NYSE:ABB) has spent billions since 2010 acquiring competitors and is becoming a global leader in DA technology. The company has allocated $18 billion for acquisitions through 2015, and is aiming to expand its presence in the US. Recently setting a new 52 week low, this company presents a buying opportunity for investors optimistic in incremental smart grid expansion. Forbes recently categorized ABB as oversold based on its Relative Strength Index, and as having strong fundamentals. With a high earnings growth rate relative to price, and comparatively little long term debt, ABB stands to benefit from smart grid expansion. As the industry rises from the Valley of Despair, investors should be prepared to ride the incremental transition to smart grids.

Disclosure: I am long BA, IBM.