With the Lights Out…

A.J. LIEBLING WAS ONE OF THOSE GREAT New Yorker writers of an era long gone. Some of his best material came as a war correspondent during World War II. And one of his greatest essays was “Westbound Tanker.” It’s about how Liebling hitched a ride with a Norwegian oil tanker to make the danger-filled trip across the Atlantic.

Some of his observations at sea remind me about how we deal with certain infrastructure problems, such as our aging power grid. Most people don’t think about the fragility of the power grid until the lights go out.

“Danger at sea is like having a jumpy appendix,” he writes. “Men can live with it for years, knowing in an academic way that it may cause trouble, but forgetting about it most of the time.”

People, too, like to press their luck. The seamen aboard the Norwegian tanker Regnbue considered it a lucky ship. It had crossed the Atlantic 14 times without ever spotting a dreaded conning tower. But luck and risk are funny things. “The Meddelfjord was a lucky ship, too, before the last time,” says one of the seamen.

In making its trip across the Atlantic, the Regnbue took risks. German submarines were no laughing matter. But the odds of a German submarine sinking any tanker were somewhat low. Small comfort, perhaps, but comfort, nonetheless. As Liebling writes: “The Battle of the North Atlantic sounded imposing, but it was rather like a football game with five men on a side.” There were never enough ships for convoy duty, but there were never enough German submarines, either.

“It is not a great risk to take once,” Liebling writes of crossing the Atlantic. “The men on the Regnbue live continually with this risk, which is quite a different thing.”

Likewise, the risk of any single power station failing may be low, but if you continue to take that risk — year in and year out, over many miles of infrastructure — it becomes a much more likely event.

All of this is a rather lengthy prelude to some thoughts on our aging power grid.

Summer, the time for our country’s annual gamble with power outages, has come and gone. The power grid that so ably supplies electricity most of the time also exists — as the Regnbue did — in a world where the consequences of the relatively rare event are large and negative.

As so much of the grid approaches the end of its useful life and we ask it to deliver more and more power, the prospects of eventual massive failure — like the big blackout of 2003 — become ever more likely. It’s like crossing the Atlantic over and over again in that war-torn world of 1941. You tempt fate with each crossing.

Those risks grow every day as the modern electricity-sucking economy gets larger. Just think of all those computers and electronic devices soaking up power. The people of this country plug in more than ever. And it shows in the data of electricity consumption. Server farms, those massive storage areas for computer networks, now drink up 4% of total U.S. electricity production. Only 10 years ago, they were practically invisible.

Microprocessors — which require a continuous flow of electricity to work — eat up roughly 10% of all electricity. The Electric Power Research Institute projects that this number could rise to as high as 50% by 2020.

Of course, given the heavy involvement of government in this sector — with regulated rates and the incredible difficulty in building anything anywhere — it is unlikely the utility industry will provide this huge increase in demand. More likely, private companies will find ways to generate their own power.

Indeed, that’s what’s happening already. Some businesses cannot afford to have confidence in the power grid. The stakes are too high for them. Too many outages and reliability problems finally pushed them to find their own sources of power. According to Barron’s, one-tenth of all electricity generation in the U.S. comes from private companies off the power grid.

Even so, the industry is under pressure to fix the grid. Utilities will spend billions on new equipment to upgrade the capability and reliability of the grid. Electricity rates, many experts maintain, will rise a ton to pay for all of this.

“The makeover facing the electricity industry is by far the most extensive in its history,” says Richard Karn, editor of Emerging Trends Report.

It’s long overdue. As Jason Makansi writes in his new book, Lights Out, there are miles and miles of transmission lines that crisscross the country that have not been touched since the 1950s. Such is the backdrop for a company that has all the tools and equipment to refurbish — if not build anew — power grids the world over.

There is an old saying among utility investors: “Buy when the lights go out.” The idea being that the best time to buy an electric utility is after a major blackout, on the theory that the utilities will get the rate increases they want after the fact. This translates into better earnings and higher stock prices.

That may be so. In my paid newsletter, Mayer’s Special Situations, I flirted with the idea of recommending a large Argentine electricity utility while Argentina worked through a major energy crisis. Again, the theory being that the government would grant rate increases and that would make the utility much more profitable.

I continue to look at ideas in this space — possibly a utility, but I’m more interested in the companies that make the components needed for an upgraded grid. There is one company that fits in this latter category. It’s delivered stunning financial results, and the stock is up 40% for us this year. It’s hard to find another company with the global platform, growth rate and strong finances this firm has shown, but I keep looking. In the meantime, I expect the power grid — and power outages — to grab a share of the headlines, both here and abroad.

As a country, we’ve been lucky so far. It’s been four years since that big blackout in 2003. But remember, the Meddelfjord was a lucky ship too — before the last time.

Sincerely,
Chris Mayer

November 8, 2007