Summary
- The recent growth in artificial intelligence (AI) is creating increased demand for data centers, which operate facilities with servers and other equipment that are part of the internet’s infrastructure.
- AI model training and running are energy-intensive processes and add significantly to the electricity needs of data centers, despite usage of renewable energy and progress to make processes more efficient.
- As power demand growth from data centers outpaces renewable energy growth, midstream companies and utility providers are forecasting that more natural gas will be needed for power generation.
The positive long-term outlook for US natural gas has largely centered on abundant domestic resources and growing demand domestically and overseas. Specifically, domestic natural gas demand is set to increase over the next few years as the US exports more liquefied natural gas (LNG) to destinations around the world (read more). While the outlook related to LNG remains solid, artificial intelligence (AI) and its related data centers add another layer of incremental natural gas demand growth. This creates opportunities for midstream companies with natural gas infrastructure. Today’s note looks at the anticipated growth in natural gas demand from data centers and how the midstream space could benefit.
Data Centers Drive Growing Electricity Demand
The growing deployment of AI technology is heavily dependent on a rising number of data centers. Data centers operate servers and other equipment that provide the data storage and processing capacity, which AI models rely on to both train and operate. Data centers provide critical internet infrastructure and use large amounts of electricity. Due to the energy intensity of their equipment, data centers can consume up to 50 times more energy per floor space compared to a typical office building. Training AI models is particularly energy intensive.
Data centers and AI models are becoming increasingly efficient, and data centers can offset their electricity needs with clean energy either on premises or through clean energy power purchase agreements. Although renewables are expected to gain share in power generation, natural gas is still the largest source of electricity in the US at 42% in 2023. Natural gas' share of electricity generation is currently expected to remain around that level through 2025. Notably, the growth in energy demand from data centers is likely to outpace the growth in renewable energy capacity, meaning traditional sources of energy will be needed to facilitate the development of new data centers. Utilities like Dominion Energy (D) are preparing for growth in electricity demand from data centers due to the rise in AI technology.
New Technology Needs Old Energy
While data centers are prioritizing greater energy efficiency and the use of renewables, there could be a scenario where power becomes a circumstantial constraint instead of processing capacity, according to Zeno Mercer, a research analyst at VettaFi covering the technology sector. Natural gas power generation may be particularly helpful for offsetting the intermittency of solar and wind, especially when demand is peaking (read more).
The rising demand for natural gas driven by data centers bodes well for the midstream companies, which operate critical natural gas infrastructure. During its 1Q24 earnings call, management from Kinder Morgan (KMI), which owns natural gas pipelines across the country, discussed anticipated growth in natural gas demand from utilities due to data centers/AI. By 2030, data centers are projected to use around 20% of US electricity, up from 2.5% in 2022, management said.
Williams Companies (WMB), which operates the Transco Pipeline that carries around 15% of US natural gas, also anticipates significant growth. Citing S&P Global Commodity Insights data, WMB’s analyst day presentation showed forecasts for electricity demand to grow three times faster per year this decade compared to last decade thanks to data centers and electric vehicles. If natural gas remains around 40% of electricity generation, that represents a meaningful increase in natural gas demand.
Midstream/MLPs Offer Exposure to Growing Natural Gas Demand
Midstream companies focused on gathering and processing (G&P) and natural gas pipeline transportation could see a lift due to increased natural gas demand for electricity generation. G&P companies transport raw natural gas from wells to their facilities, where gas is processed into usable form. Many midstream companies own natural gas pipelines, which transport gas from processing facilities or hubs to end-users like power plants.
Midstream companies are classified in the Alerian index suite by the business activity that drives the majority of their cash flows. For the Alerian MLP Infrastructure Index (AMZI), G&P companies account for 24.5% of the index by weighting, while gas pipeline transportation companies account for 24.6% of the index as of April 25. G&P accounts for 30.5% of the Alerian Midstream Energy Select Index (AMEI), while gas pipeline transportation accounts for 38.6% of the index by weighting as of April 25.
With significant weightings to natural gas-focused midstream companies, both indexes offer exposure to increased natural gas demand from utilities due to data centers/AI and would benefit from related natural gas production growth to meet incremental demand.
Bottom Line:
The constructive long-term outlook for US natural gas has improved further with expectations for AI and data centers to drive increased natural gas demand for power generation. This outlook benefits the midstream companies that operate critical natural gas infrastructure like pipelines and gas processing plants.
Related Research:
Midstream Positions for Ballooning U.S. LNG Exports
Williams (WMB) and the Golden Age for Natural Gas
AMZI is the underlying index for the Alerian MLP ETF (AMLP) and the ETRACS Alerian MLP Infrastructure Index ETN Series B (MLPB). AMEI is the underlying index for the Alerian Energy Infrastructure ETF (ENFR) and the ALPS Alerian Energy Infrastructure Portfolio (ALEFX).
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