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 EPA’s required environmental standards. The company would need to invest approximately $7 billion to $8 billion to meet the energy policy’s 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.

RELATED TERMS
  1. Electric Utilities Industry ETF

    An exchange-traded fund that invests in companies which generate ...
  2. Utility Revenue Bond

    A type of municipal bond that is issued to finance utility projects, ...
  3. Utility

    1. An economic term referring to the total satisfaction received ...
  4. Total Utility

    The aggregate level of satisfaction or fulfillment that a consumer ...
  5. Expected Utility

    An economic term summarizing the utility that an entity or aggregate ...
  6. Marginal Utility

    The additional satisfaction a consumer gains from consuming one ...
Related Articles
  1. Insights

    Trust In Utilities

    Even in times of economic turmoil, utilities can be a good investment.
  2. Investing

    The Debt Report: The Utilities Sector

    Discover how blue chip U.S. utilities companies are using debt, and why it was important for the industry to deleverage after the financial crisis.
  3. Investing

    The Top 5 Utility ETFs for 2016 (XLU, IDU)

    Discover the top utility company ETFs, and learn more about how you can get exposure to water, electricity and natural gas utility companies.
  4. Investing

    Power Utility Stocks to Benefit as Fed Holds Rates (CMS, PCG)

    Here’s how the low interest rate environment will continue to benefit power utility companies.
  5. Investing

    Are Safe Haven Utility Stocks, ETFs Too Expensive?

    With so many investors seeking safety are utility stocks and ETFs a crowded trade?
  6. Financial Advisor

    Why Utility Stocks Are No Longer a Safe Haven

    Utility stocks have been the best performing sector in the S&P 500 Index so far this year but many believe they are now overvalued.
  7. Investing

    Utilities Sector: Industries Snapshot (NEE, GAS)

    Discover how the utilities sector is broken down into different subcategories that each function to fill a different need.
  8. Investing

    The Top 5 Utility Mutual Funds for 2016

    Understand how utilities equities play a role in asset allocation, and discover the best utilities mutual funds to consider for 2016.
  9. Investing

    ETF Flows: Utilities ETFs Stand Tall in 2016

    Find out which utilities exchange-traded funds (ETFs) have benefited the most from the huge surge in fund inflows in the early part of 2016.
  10. Investing

    Top 4 Utilities Mutual Funds

    Discover which mutual funds in the utilities industry are top rated, and learn how investors can include utilities as part of an asset allocation strategy.
RELATED FAQS
  1. What are the main factors that drive share prices in the utilities sector?

    Learn why the share prices of companies in the utility sector have sensitivity to interest rates and to changes in the amount ... Read Answer >>
  2. To what extent are utility stocks affected by changes in interest rates?

    Explore the current state of the utilities sector, and learn about the different ways an increase in interest rates may impact ... Read Answer >>
  3. What is a utility stock?

    Investing in difficult economic conditions requires knowledge of different stock classes. Utility stocks are one vehicle ... Read Answer >>
  4. What are the top investing strategies for investing in the utility sector?

    Employ the right strategies when investing in the utility sector, and you can see consistent returns with less risk than ... Read Answer >>
  5. What kind of investors buy utility stocks?

    Take a look at why income investors like utilities, why value investors might like utilities and why growth investors tend ... Read Answer >>
  6. What is the average annual return in the utilities sector?

    Explore facts about the popular utilities sector and discover what the average annual return for the sector has been over ... Read Answer >>
Hot Definitions
  1. IRS Publication 970

    A document published by the Internal Revenue Service (IRS) that provides information on tax benefits available to students ...
  2. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  3. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  4. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  5. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  6. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
Trading Center