The Utility sector is at a crossroads after the release of the new emission standards by the U.S. Environmental Protection Agency (EPA) last August. The finalized version of the Clean Power Plan calls for CO2 reduction of 28% by 2025 and 32% by 2030, from 2005 levels.

The beginning of the New Year turned out to be a nightmare for investors. China-led weaknesses in the international markets and continuously falling oil prices have resulted in a 5.5% decline in the value of Dow and a 6.9% fall for the S&P 500 in January. The sell-off in the markets has made a further rate hike in March almost impossible. The gyrations in the market enhance the appeal of relatively stable sectors like the utilities known for their dividend yields and assured returns.

 
As would be expected, larger utilities with more financial strength and better access to capital are better placed to achieve regulatory compliance. This is also likely to trigger more consolidation in the utility landscape, with a definite focus on generating electricity from natural gas and renewable sources. As a result, we expect to see higher solar installations across the U.S. The extension of investment tax credits and production tax credits will further support solar and wind installations in the next few years.

The combination of steady electricity price gains and stable-to-improving demand will drive the utility sector. A decline in the unemployment rate, increase in hourly earnings of average workers and higher demand in residential and other customer classes are tailwinds for the utilities.

Rising up to the environmental challenge, utility companies are steadily improving their operations by investing in more environment-friendly power generation facilities. Per a recent release from the U.S. government’s Energy Information Administration (EIA), the electricity industry retired nearly 14 gigawatts (GW) of conventional steam coal-fired generating capacity during 2015. These retirements represented 5% of the amount of operating steam coal capacity at the end of 2014.

The industry plans to further retire 10.7 GW of coal fired units during 2016 and 2017. Apart from the Clean Power Plan, the recent spate of coal-fired plant retirements has largely been influenced by the need to comply with the Mercury and Air Toxics Standards. Low natural gas prices have also been a stimulus.

We believe a constructive utility rate environment, increase in electricity production from natural gas and renewables and investments in infrastructure upgrade projects will enable the utilities to efficiently serve a larger customer base.

In the segment below, we discuss the basic strengths of the utility sector.

Regular Dividend & Share Buybacks

Utility operators generate more or less stable earnings unless there are severe factors disrupting their operations. The regulated nature of operations provides stability and removes volatility from future earnings. These operators in turn reward their shareholders through the payment of sustainable dividends and share buybacks. This was evident during the economic crisis of 2008–2009 when utilities continued to pay dividends without fail.