Investors exploring fresh avenues into the stock market's surge in artificial intelligence are turning their attention to an unexpected sector: utilities, typically the least glamorous field in equities.

Artificial intelligence is currently a major buzzword, captivating sectors from automotive to technology manufacturing, each aiming to be associated with its promising prospects. This enthusiasm has notably influenced the recent uplift in stock market dynamics.

For instance, last Thursday witnessed a significant drop in Meta Platforms Inc.'s shares, marking their most substantial decline since October 2022 after announcements of increased AI development expenditures. Conversely, on Friday, Alphabet Inc., Google’s parent company, saw its market valuation eclipse $2 trillion, with Microsoft Corp. also experiencing gains, thanks to noticeable advancements in AI showcased in their quarterly reports.

However, the development and operation of AI technology require vast amounts of energy. Consequently, utility companies are becoming increasingly crucial.

"Data centers have long been major power consumers, but with the surge in AI enthusiasm, the demand for power has skyrocketed," stated Manju Naglapur, senior vice president and general manager for cloud, applications, and infrastructure solutions at Unisys Corp. "With substantial investments directed towards data centers, power consumption is expected to rise significantly."

Despite experiencing a 10% decline in 2023, marking its worst performance since 2008, the S&P 500 Index's utilities sector has begun to recover. Rising 4.4% in 2024, utilities are mitigating higher refinancing costs and unprecedented capital expenditures through cost control measures. Yet, a newfound optimism in utilities is largely driven by the anticipated surge in demand stemming from power-intensive data centers needed for AI expansion.

Ryan Levine, head of utilities coverage at Citigroup Inc., highlighted, "The AI narrative is now the foremost attraction for investors, potentially becoming the primary industry driver." Across the U.S., utility providers are gearing up for historical spikes in electricity demand driven by data centers and AI applications. Even beyond Northern Virginia's Data Center Alley, where Dominion Energy Inc. had to halt new data center connections in 2022 due to grid limitations, plans for new power plants and transmission lines are underway.

Calvin Butler, CEO of Exelon Corp., recently noted an expected 900% increase in power demand from data centers in the Chicago area, potentially necessitating as much power as four nuclear plants. Southern Co. anticipates a 6% annual increase in electricity sales, with about 80% attributed to data centers.

Goldman Sachs Group Inc. has responded by creating two investment baskets — Power Up America and Data Center Equipment — for clients looking to capitalize on the AI boom. While specifics of the stocks included remain undisclosed, selections are based on categories including regulated and unregulated utilities, smart-grid infrastructure, and power-generating materials.

"Over the next few years, these themes, alongside Goldman's Broad AI basket, are projected to be the most popular," mentioned Faris Mourad, vice president of US custom baskets at Goldman Sachs, during a phone interview.

To date, the Power Up America basket has surged nearly 28%, and the Data Center Equipment basket has increased over 18%. These figures are particularly striking compared to the broader S&P 500 tech sector's 8.3% gain in 2024.

Energy availability plays a critical role when data center operators decide on locations. Typically, they approach local utilities to ascertain power availability before seeking regulatory approval for new facilities or purchasing power from third parties. For instance, Georgia Power recently received approval from the Georgia Public Service Commission to expand its capacity by 1.4 gigawatts to accommodate rising demand from data centers and other industries.

"The access to renewable energy sources is also a significant advantage," said Aaron Dunn, co-head of value equity and portfolio manager at Morgan Stanley Investment Management. He favors NextEra Energy Inc. for its dual focus on building renewable generation for its utility operations and developing renewables for third-party clients.

As data center developers seek cost-effective sites, the Midwest is poised to become a focal point due to its relatively low land costs. "This benefits companies like CMS Energy Corp., based in Michigan," Dunn added. Indeed, CMS confirmed during its earnings call that it signed a contract for a new 230-megawatt data center in Michigan, with other firms also looking to establish operations in the state.

However, the anticipated surge in demand presents substantial challenges for traditional utilities, requiring significant grid enhancements to meet the escalating power needs. Investors are increasingly focusing on companies that will strengthen the grid to help utilities cope with the new high-energy demands, concluding that these firms will likely benefit most from the capital directed towards grid upgrades.