How to plug into America's $4.5bn energy upgrade

Every summer, as sweltering heat descends on its major cities, America flirts with blackout. Steam rises from the scalded streets and millions of air conditioners are switched on as people retreat indoors, sending the power grid into overdrive. It may seem unbelievable that the system powering the world's biggest economy could be so vulnerable to disruption, but the truth is that it doesn't take much to throw the whole network into meltdown.

In fact, in the summer of 2003, all it took was a lone tree in a northeast Ohio town. Sunken from the mid-day heat, a 350,000-volt power line brushed against a roadside tree, setting off a chain reaction that would end up causing more than $6bn worth of damage. The local power grid was tripped, sending a surge that short-circuited power systems from Detroit to New York. Traffic lights failed, subways were evacuated and thousands of people were trapped in lifts in offices and apartments. It was the biggest blackout in American history, with more than 50 million people ending up in darkness that night.

So what went wrong? In the investigation that followed, it was found that in the precious minutes following the Ohio outage, the managers of the local power utility, spooked by a dip in voltage on their grid, had to phone the regional system operator to find out what was happening on their own wires. By then a whole raft of disturbances had gone unnoticed. Power lines were being tripped across the state, and with no way to find out quickly what was happening where, a dangerous surge in electricity was on its way to the coast and power plants were shutting down by the minute to avoid meltdown.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The key problem is that there hasn't been any significant capital invested in the US power grid for 20 years. It's a relic, using none of the technology that we now take for granted in almost any other crucial modern-day supply system, says Climate Solutions' research director Patrick Mazza. Take stock-control systems, for example. These keep a constant track of inventory levels through systems that link check-out to warehouse, so that if stocks look in danger of running out, they can be replenished. A utility, on the other hand, has no such systems instead, it "must send its linemen into the field to hunt out downed power lines". And so simple outages that could be stopped at source end up knocking out whole cities.

This is why, of the many bits of spending announced in US president Barack Obama's stimulus package, the $4.5bn going on upgrading the national grid could be the most worthwhile. The plan is to work towards a 'smart grid' armed with devices that tell everyone, from the utility company to the system operator, when the circuit has been tripped.

And there's not much time to waste. Demand for electricity is expected to increase by 45% by 2025, according to the North American Electric Reliability Council (NERC), stretching the threadbare grid to breaking point. A study by the Battle Group estimates that utilities will have to spend more than $1.5trn between 2010 and 2030 just to maintain today's level of service.

So what exactly is a smart grid?

The short answer is that it's just a smarter version of the current electricity grid. The existing grid was designed more than 50 years ago, and is often described as the largest interconnected network in the world. It contains 157,000 miles of high-voltage transmission lines, connecting everything from power stations in Upstate New York to electrical substations on the outskirts of the Bronx, to electrical appliances in an apartment on 55th and 3rd in Manhattan.

The trouble is, it's not very efficient. The power station makes electricity, then sends it down the power line whether you need it or not. That means that you either get a lot of waste or, when demand outpaces supply, you are in danger of getting a blackout. Indeed, the Electric Power Research Institute estimates that power outages and power-quality disturbances cost American businesses more than $120bn a year.

The key improvement a smart grid brings is the installation of automated meter technology all along the network. In today's grid, if there is a surge in demand, the electricity firm has to phone up its power plant and tell it that it needs to pump out more juice. With a smart grid, smart meters and sensors along power lines instead allow for two-way communication between the customer and the plant. The grid becomes 'self healing'. It is able to monitor supply and demand and so anticipate and respond to problems much more rapidly. That means power outages and quality issues can be solved before they cause too much disruption, according to UtiliPoint International. So, for example, a factory on the Steel Belt in Michigan can monitor how much energy it uses and when it uses it, while a power plant in Ohio can distribute it more efficiently by analysing data that show when demand peaks and wanes.

Sound far fetched? Well, it's happening already. Austin, Texas, has been working on its own smart grid since 2003, when the local electricity utility replaced a third of its manual meters with smart ones. Using the feedback from smart meters, thermostats and sensors, Austin Energy can now monitor and solve power outages and cut offs without having to send its men out in trucks after every disruption to try to find out what's happening. Meanwhile, Colorado-based Xcel Energy is turning the city of Boulder into America's first "Smart Grid City", spending some $100m fitting 35,000 homes and businesses with the technology to allow for two-way communications.

And they're not the only ones. Southern California Edison is spending $1.63bn to install 5.3 million meters between now and 2012, while Pacific Gas and Electric, and a wide range of other power firms, are all installing automated technology along their networks. This is good news for the likes of Itron and Esco Technologies, which provide the two-way communication gear for utilities and their meters (see below). Other companies, such as EnerNOC Inc (NASDAQ:ENOC), offer demand response programmes installing onsite meters, software and monitoring power use to businesses. This allows the firm to cut energy use during peak hours when power plants are stretched.

But the smart grid is not just about new technology. The basic infrastructure of the grid also needs to be expanded in order to bring renewable energy to cities and urban areas. Currently, the state of Nevada can produce enough solar electricity to meet the needs of the entire US, claims oil explorer-turned-renewable energy entrepreneur T. Boone Pickens in the Chicago Tribune. "But inadequate transmission prevents shipping it to major cities to meet demand." The same goes for wind energy, concentrated as it is in the Midwest and Great Plains. If America wants to get even 20% of its energy from renewable energy by 2024, it will have to build 15,000 miles of high voltage lines, according to the Energy Information Administration, to shift energy from windy states such as Oklahoma to urban areas where it is needed. So a further $7.5bn has been set aside in the stimulus package to rewire the old grid.

This focus on green power is another reason why smart-grid technology is needed. Wind farms and other renewable sources tend to be inconsistent energy providers. When the summer heatwave descends, wind farms run at between one-third and one-half of their normal output, notes Tom Konrad on AltEnergy Stocks. To make green energy workable, the US needs a grid capable of dealing with this intermittent supply and of ensuring other sources are available when necessary. That means networking millions of energy devices from wind turbines to solar panels and even electric vehicles, along with the older, more reliable, fossil fuel plants.

The green lobby is behind the project. The US power grid is the source of a third of the nation's greenhouse-gas emissions. The Department of Energy claims that a 5% improvement in grid efficiency would be the same as permanently eliminating harmful emissions from 53 million cars. And importantly, in these recessionary times, if 40 million homes had smart meters, the US Department of Energy reckons that energy costs would be lowered by $46bn over 20 years. Given enough time, the smart grid could even end up paying for itself.

Building all this will take some time (see below). In the meantime, for the handful of firms being charged with fitting the new grid, the initial $4.5bn investment is only the start of years of spending, says Jim McTague in Barron's. Battle Group reckons that around $880bn in transmission and distribution investment will be made by 2030. With political will behind it and a real need to improve America's ancient infrastructure, the smart-grid project looks like a winner, despite the recession. We take a look below at some of the firms poised to benefit.

The next big challenge: storing all that energy

America is not going to build a fully functioning smart grid overnight. An internet-like grid with power distributed among solar panels, utilities and grid operators, all in perfect chorus is some way off. These are baby steps. A major challenge will be developing the digital technology to enable communication between everyone from the load forecasters to distribution, maintenance and metering. And given an ageing and underpaid workforce and lack of investment in the power system, upgrading the grid will take no small amount of technical training, notes The Electricity Advisory Committee (EAC) in its December report[pdf] on the smart grid.

Backing up the power grid by improving methods of energy storage is another challenge to be tackled. This area is often overlooked, but energy storage devices are essential to enable efficient use of renewable power, says John Peterson on AltEnergy Stocks, which is less reliable than traditional power sources. Most estimates of annual demand for storage devices forecast growth from $25bn to $100bn over the next decade. One practical way to store electricity is through pumped hydro an underground hydro-electric system where water is pumped between two flooded mines as and when needed. Compressed air energy storage also looks interesting, according to the EAC in its 'Bottling Electricity' report. By compressing air in depleted gas fields and decompressing later, energy can be stored for long periods of low energy in off-peak hours.

A more immediate means of storing energy is using large-scale lead and lithium-ion batteries. Potential use of lithium-ion batteries for high-power transportation, such as electric vehicles and light rail, has helped drive sales in the US to $1bn in 2007, and they continue to grow strongly. It's the automotive market where the biggest strides in developing batteries have been made. Huge demand for energy storage will come from plug-in hybrid electric vehicles, according to the EAC. These will rely on the electricity grid for their fuel, with two million expected to be on the road in the US alone by 2016. Utilities in the States and Japan are already well behind this idea. As one Tokyo Electric Power chief told the FT recently, utilities like electric vehicles because it allows them to sell electricity at night. Most drivers prefer to charge their cars at home during the utility's off-peak hours, using regular power sockets.

The US Department of Energy is already studying the implications of plug-in cars grabbing a 25% share of the market. We have a look below at the best way to benefit.

The four stocks to buy now

Although giant conglomerates such as GE are involved in making smart meters, Itron (NASDAQ:ITRI) is the market leader, making products that monitor everything from electricity to water usage. Based in Washington state, it's one of the firms "better positioned to benefit" from the Obama $4.5bn stimulus plan, says Investment Bank Merriman Curhan Ford. Itron is currently in negotiations with utilities such as San Diego Gas & Electric to install meters.

The slowdown in housing starts has had an impact on the business, with revenues for 2008's fourth quarter coming in just below broker forecasts at $432m. Itron also expects annual revenues to fall by 4% in 2009. However, it "remains a leader in a vastly under-penetrated market that should see a stable three to five year growth outlook as utilities begin to upgrade meters worldwide". It trades on a forward p/e of 11.3.

EnerNOC (NASDAQ:ENOC) also sells energy management devices, such as meters, to the utility market. Although still losing money, the group posted a lower-than-expected fourth-quarter loss of $12.2m. The Boston-based company expects to generate positive cash flow from its operations in the second half of 2009, and to report a profit next year. Analyst Jeff Osborne at Thomas Weisel LLC has a price target of $18 on the stock, which currently trades at around $11 a share. "EnerNOC remains an attractive investment in a difficult market," he said in a note. "We view the demand response industry as an attractive entry point into the otherwise staid world of conventional electricity."

One firm that should do well regardless of the impact of the Obama stimulus is General Cable (NYSE:BGC). It makes electrical cables in 23 countries, although the US and Spain account for 43% of revenues. It reported revenues of $1.3bn in the fourth quarter of 2008, 20% higher than the same period in 2007. "I do not believe that spending initiatives coming from the government's stimulus bill are necessarily incremental for the overall spending that would have occurred by the private sector on its own over time," Greg Kenny, the chief executive, said recently. In other words, "Obama's plans may hasten construction a bit, but networking and energy companies like AT&T and TECO Energy would have ordered the same number of communications and power cables from providers like General Cable anyway", says The Motley Fool. General Cable is a fine business "selling at ridiculous low valuations", says the Fool, trading as it does on a forward p/e of five.

Meanwhile, Obama's hopes to put a million electric cars on the road by 2012 will put pressure on companies such as Ener1 (NASDAQ:HEV) to come up with the goods. The firm develops the lithium-ion batteries that will be necessary if electric cars are to have a viable future. Washington DC lawmakers plan on spending $2bn in loan guarantees and grants for makers of advanced batteries. However, the technology is still highly speculative, so investing in this stock is a bit of a punt.