How will AI drive energy demand?

How will AI drive energy demand?
How will AI drive energy demand?

Alex Monk discusses the outlook for actions related to the energy transition and how AI is influencing energy demand.

By Alex Monk, Portfolio Manager, Global Resource Equities

How did the energy transition sector behave in the 1st quarter of 2024?

Alexander Monk

After a strong close at the end of an otherwise difficult 2023, unfavorable cyclical forces are maintaining pressure on energy transition-related stocks at the start of the year.

More persistent than expected inflation, resilient economic data and continued fiscal largess have led to a return to higher bond yields, again weighing on sector valuations. At the same time, subdued profit forecasts in key consumer markets and for companies exposed to falling electricity prices, add to the challenges facing the sector.

However, despite these short-term difficulties, there are signs of better prospects.

Demand in consumer-driven markets begins to stabilize as EV charging and heat pump inventories drain, and companies in the residential solar segment expect demand to recover throughout the year. Utility-focused markets are also experiencing better fundamentals, with resilient demand, supply chains normalizing, and regulators adapting to the new macroeconomic regime. Earnings strength in the electrical equipment segment and other low-cyclicality markets should also not be overlooked.

The positive reaction of stock prices to some of this news during the quarter highlights the improving risk-reward tradeoff as earnings uncertainty in the sector begins to ease.

Valuations in the energy transition sector remain attractive, as evidenced by new share buybacks and M&A transactions in the segment.

What is the impact of AI on the energy transition?

The rapid growth of generative AI is accelerating the transition to higher electricity demand. The combined effect of data center expansion, higher energy intensity linked to AI computing needs and the quest for decarbonized energy presents exceptional profit growth opportunities for companies in the energy transition sector.

Meeting the growing energy needs of AI in a decarbonized way cannot rely solely on nuclear or gas with carbon capture. It will also require cheap and quickly available renewable energy sources, including wind, solar, geothermal, hydropower, backup storage and e-fuels.

Furthermore, even if gas turbines or nuclear power become the energy sources of choice for data centers, the resulting strains on conventional energy markets would have the effect of increasing energy prices. electricity and would also benefit sustainable energy suppliers.

For now, the market is focused on the immediate beneficiaries of AI, including large technology and data center companies, and those that provide energy to the grid. But more companies, including those in the sustainable energy sector, are likely to benefit from the ongoing structural change. The divergence in valuations between electrical equipment and renewable equipment, and between energy production conventional and renewable energy, despite comparable levels of future earnings growth, highlights the ability of energy transition-related stocks to benefit from AI growth.

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