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Utilities are, by design, a bit of a snooze. We feel no excitement at the miracle of instantaneous light, television and coffee grinding, expecting these things simply to happen when we want them to — which, virtually all the time, they do. Similarly, investors own utilities for their steady dividends funded by all of us unthinking bill-payers. This mundane arrangement has fed widows and orphans for decades.
Oil, on the other hand, is wild; a never-ending dance of discoveries, disappointments, Viennese jamborees, wars, trade, presidential tweets and palace intrigues. At times, we really have worried about the pumps running dry. Fortunes and whole economies are lost when prices crash, but the allure of the next killing has been impossible for more adventurous investors to resist.
This isn’t the first time the oil-heavy S&P 500 Energy index has offered a higher dividend yield than utilities (that was in August 2015). But we’ve now had almost four months of this situation, by far the longest run, and the spread has widened. After almost three decades of utilities offering roughly 1 to 3 percentage points of extra yield compared to their oilier energy brethren, the script seems to have flipped.
One explanation for this is, as you might expect with utilities, rather prosaic. Valued as bond proxies, they have been towed along more than most by the bull market in debt. Current economic fears help, too.
There is also a potentially more interesting interpretation to consider here: What was growth is now viewed as value, and vice versa.
The first decade of this century was dominated by China’s commodity-hungry growth spurt and fears of peak oil supply. The oil business was spewing cash, but also investing a lot of it in new fields. After the brief buzzkill of the financial crisis, oil was pushed back into triple digits, making this seem like the new normal and spurring yet more drilling, including in
US shale. That all changed with the oil crash beginning in late 2014. Investors woke up to the reality that the world was awash with oil and the industry’s
investment binge had trashed return on capital.
Utilities, meanwhile, continue to enjoy reasonably steady earnings growth. While US electricity demand has flatlined, demand doesn’t drive earnings for regulated utilities; investment in old grids (including for natural gas) does, and that has kept on going. In other words, a utility with ever-expanding capital expenditures rewards investors regardless of demand for electrons. The same cannot be said for oil and gas spending.
Importantly, electricity’s expanding share of energy demand, and especially the rise of renewable power, give this old value sector a more credible growth story. We’re talking more like 4 percent or 5 percent per year rather than the double-digits touted by frackers. But the latter narrative has worn thin and the utilities’ targets look more dependable. The upshot is that money has moved into utilities, attracted by the dividends, yes, but also the promise of growth. With their own growth narrative having ebbed, oil
and gas producers must pay investors to hold their stocks.
—Bloomberg