By Avi Salzman

Morgan Stanley analyst Stephen Byrd told investors early in 2024 to buy a small set of obscure power companies that he thought could profit from the artificial intelligence boom. That included Constellation Energy, Vistra, Public Service Enterprise Group, and NRG.

By the end of the year, those names were some of the biggest winners in the stock market. Constellation and Vistra have risen 94% and 263% respectively, in 2024. The other two are also well ahead of the S&P 500.

Byrd is still upbeat about the opportunity for power stocks like Constellation as big tech companies invest in new data centers and look to power-plant owners to supply the electricity. But he and his fellow Morgan Stanley analysts Devin McDermott and Robert Kad think a different group of stocks may now have the most opportunity for rocketship-like gains.

The winners in 2025 could be companies that produce and transport natural gas, Byrd said in an interview. That includes companies like natural-gas producers EQT and Antero Resources, and pipeline companies Energy Transfer and Williams Companies.

Natural gas is already the largest source of electricity generation in the U.S., and it could grow in importance as electricity demand rises. There are signs that is already happening: Companies that make turbines for natural gas power plants such as GE Vernova have said that demand has roughly doubled from a year ago.

"We're starting to get quite bullish on the handful of gas names that should do well," Byrd said. "I think it's more than hype."

Byrd's thesis is based on his expectations for how much power the big tech companies will need to fulfill their AI ambitions. Estimates vary widely for how much electricity will have to be added to the grid in the next few years, but it will clearly be a lot.

Goldman Sachs has said that electricity demand is likely to rise by about 2.4% a year through 2030, after remaining flat for the past decade. Morgan Stanley estimates that data centers will need 57 gigawatts worth of new power capacity by 2028, or as much as 27 Hoover Dams, given how many advanced AI chips are being sold.

The problem is that there are only 12 to 15 gigawatts of power capacity available now, and another six gigawatts being built. That leaves the country at least 36 gigawatts short, Morgan Stanley's data indicate.

There are a few ways to close that gap. One is to turn Bitcoin mining data centers into AI data centers, a trend that has already been happening with Bitcoin miners like Core Scientific. But that could only take care of one-third of demand at most, Byrd says.

Byrd also thinks that companies such as Constellation that own nuclear reactors could sign special deals with tech companies to connect those reactors directly to data centers. Those kinds of deals are currently limited by a federal regulatory decision, but could move forward again next year, he projects.

But the most interesting source of untapped potential may be in natural gas: Byrd expects demand to rise to supply new power plants. Some of that generation capacity may even be built on the same land as new data centers, designed so the centers can plug directly into the plants rather than having to connect to the larger grid.

In utility parlance, these setups are known as "behind the meter," because the activity is taking place on the consumer's side of the electric meter. The deals offer tech companies a way around the lengthy transmission-approval process that can delay the rollout of new data centers for years.

Natural gas companies can benefit because the power-plant owners will want to sign up long-term fixed-price contracts with producers and pipeline companies so they know they will be able to supply their plants with gas for years, Byrd said.

Williams Companies, which owns pipelines and other natural gas infrastructure, told investors on a conference call in November that it is working on behind-the-meter deals. "There's a number of very detailed discussions going on," said CEO Alan Armstrong.

Valuations are modest for the producers. EQT is trading at 15 times its expected earnings for the next four quarters, while Antero Resources is at 14 times. The pipeline stocks have already started rising, but Byrd thinks they can keep going up as they begin to sign new AI-connected deals.

The natural gas stocks look a little like Vistra did a year ago, right before investors began valuing it at a much richer multiple, he said. "There's definitely a possibility of re-rating, which gets me pretty excited," Byrd said.

Byrd's past predictions mean it is worth paying attention.

Write to Avi Salzman at avi.salzman@barrons.com

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December 28, 2024 03:30 ET (08:30 GMT)

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