Utilities Sector

What is the 'Utilities Sector'

The utilities sector is a category of stocks for utilities such as gas and power. The sector
contains companies such as electric, gas and water firms, and integrated providers.
Because utilities require significant infrastructure, these firms often carry large amounts
of debt; with a high debt load, utilities companies become sensitive to changes in the
interest rate.

BREAKING DOWN 'Utilities Sector'

As high-yielding equity investments, utility stocks are subject to interest rate risk. As a
result, higher interest rates mean increased cost of capital for utility companies. For
example, in 2015, the U.S. Environmental Protection Agency (EPA) proposed a plan for
lowering carbon pollution from domestic power plants by 30% from 2005 levels by
2030. Electric utilities relying mostly on coal and without appropriate retrofit for scaling
down their carbon footprint would be the most affected. DTE Energy management
estimated needing $15 billion to upgrade energy infrastructure to match the EPAs
required environmental standards. The company would need to invest approximately $7
billion to $8 billion to meet the energy policys standards.

Debt Levels of the Utilities Sector

Because utilities are capital-intensive, they need a continuous inflow of funds for
carrying on their infrastructure upgrades and growth. The processes are necessary for
maintaining the continuous supply of electricity, fresh water, gas and other basic
amenities. Utilities use some funds generated from operations, but most funds are used
for paying dividends. External sources are typically used for financing capital
requirements.
As a result of relying on other financing methods and depending on market conditions,
utilities companies may end up paying higher interest rates on their debt. Borrowing at
higher rates contributes to the companies increasing debt levels, resulting in steep
debt-to-equity ratios impacting the companies credit ratings. When credit ratings go
down, utilities companies have difficulty borrowing funds at reasonable rates. As a
result, the cost of operations increases.

Consumer Impact on Utilities Sector

Because many states let consumers move from one utility operator to another,
consumers typically choose the least expensive operator in the area. Higher-cost
producers are eventually eliminated from the market unless they can cut their costs.
Long-term power purchase agreements between companies and consumers also impact
profits. When utility generation costs increase, companies still have to follow contract
agreements and sell utilities at preset rates, which decreases their profits.
Because utility stocks pay reliable dividends like bonds do, the stocks compete with
bonds as consumer investment options. After the financial crisis of 2008, and the
resulting almost-nonexistent interest rates lasting a long time, utility companies
benefitted from conservative investors buying the companies stocks rather than bonds.
In contrast, increasing interest rates make buying bonds more attractive than buying
utility sector stocks, further affecting utilities companies funding.

Read more: Utilities Sector Definition | Investopedia

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